Herman decided to give his wife, Angie, lump sum alimony in their collaborative divorce. He didn’t want it to be taxable to her. He was okay with not taking any tax deduction on his side of the transaction. They can do that. It is legal.
He and his attorney told Angie and her attorney that the alimony in his offer is non-taxable. Angie would get to keep the entire lump sum and none of it would be taxable. Great. Angie considered the lump sum in relation to her cash needs. Looks good.
But, when the agreement was typed up for signatures, it said that Angie was getting her lump sum alimony money from Herman’s IRA account. Herman was going to transfer that IRA money to Angie. He was not going to withdraw it, pay the income tax due and then hand it to Angie. That meant Angie would have to pay income taxes on her alimony when she withdraws it from the IRA. When I point this out to her, she and her attorney are no longer happy.
Surprises are not fun in divorce proceedings. Angie and her attorney started packing their stuff, ready to walk out.
I sat down with Herman and his attorney to try to figure out how he could give Angie a lump sum that will not be taxable to her. After all, he had offered that to her.
He didn’t want to part with any of his cash-in-bank. So, we scoured his IRA and discovered that it included a large chunk of post-tax contributions. This meant that Herman could use the post-tax contribution money for the lump sum alimony. Angie would not have to pay income tax on the alimony money she withdraws from the IRA. Angie and her attorney were back to happy.
Income taxes are hidden in all kinds of places. Be careful.