Know this: the Tax Cuts and Jobs Act (TCJA) permanently eliminated federal income tax deductions for alimony payments required by divorce agreements executed after 2018.
On the other side of the coin, recipients of such non-deductible alimony payments do not have to include the alimony in gross income.
So, under current law, alimony payments are no longer deductible for payers and alimony payments are no longer taxable income for recipients.
This development is an expensive game-changer if you are a higher-income individual who must pay alimony under a post-2018 divorce agreement. Before the TCJA, you could reap big tax savings by deducting alimony payments, but those days are gone.
If your divorce is still in process, what can you do to compensate for the loss of alimony deductions? Good question.
Redeeming Your Spouse’s Closely Held Stock Can Potentially Negate the Need for Non-deductible Alimony Payments
Here’s the situation: your soon-to-be-ex-spouse owns part of the stock in your closely held corporation. In the nine community property states of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, your spouse’s ownership may be due to applicable community property law.
In any case, you now want to buy out your soon-to-be-ex’s stock and also (hopefully) have the buyout money eliminate the need for some or all of the now non-deductible alimony payments that might otherwise be necessary to reach a divorce agreement.
You can potentially accomplish the buyout with a stock redemption deal wherein the corporation buys back some or all of your ex’s shares.
Even better, you can work the tax results from a stock redemption to your advantage.
Tax-Planning Secret Weapon: Make the Special Election to Reverse Normal Tax Results and Instead Tax Your Spouse
Tax knowledge is powerful.
IRS regulations allow a divorcing couple to elect whether the non-transferor spouse or the transferor spouse will bear the tax consequences of a divorce-related stock redemption.
So, a divorcing couple can elect to have the transferor spouse (your soon-to-be ex, the person whose shares are actually redeemed) taxed on the redemption instead of the non-transferor spouse (you), even though the redemption is made by the corporation to fulfill a primary and unconditional obligation of the non-transferor spouse (you).
With this special election, there is no federal tax impact on the non-transferor spouse (you). Perfect!
Because the rules are so flexible, divorce-related stock redemptions are fertile ground for tax planning.
You now know one way to get better tax results if you might otherwise have to make now non-deductible alimony payments.