For decades, the tax laws regarding spousal support went virtually unchanged: The paying spouse was able to deduct spousal support from their taxes, and the receiving spouse had to pay the taxes on it. In practical terms, that could help reduce the total being paid on the money and generally encouraged paying spouses to be a little more generous with their agreements.
That changed in 2019. Now, the paying spouse doesn’t get that deduction, and the income to the recipient spouse is treated the way that child support is, similar to a transfer of assets. This change has divorcing couples scrambling to figure out ways that they still reduce their taxes even without the spousal support deduction.
Some suggestions include:
- Using retirement assets in exchange for reduced spousal support. If the paying spouse has the ability to refund their retirement plan reasonably quickly, it may be smart to transfer some of the existing retirement funds in an IRA or 401(k) to the lower-income spouse. That’s done pre-tax, allowing the paying spouse to reclaim the old deduction. In return, the nonpaying spouse agrees to take a smaller payment.
- Using a charitable remainder trust. These irrevocable trusts can be funded so that the dependent spouse is the income beneficiary for the duration the spousal support is due before the remainder is distributed to whatever charity is named. That income to the dependent spouse would then be taxable — while the paying spouse would be able to take a tax break for assets that were placed in the trust.
- Using strategic planning. If you and your spouse have widely disparate income, the spouse with the lower income could take a larger share of certain assets, like stocks, and sell them without incurring as much taxes as the higher-earning spouse might.
If you have significant assets to divide with your spouse and spousal support is likely to be an issue, it’s smart to work with your spouse to find legal ways to lower your federal taxes and divide what you save.