The new tax law in the USA will have an affect on your overall divorce settlement agreement and your taxes post-divorce.
By now I’m sure that you’ve heard President Donald Trump signed a new tax law into effect back on December 22, 2017 that is sure to have big implications for just about everyone. While many of the headlines will focus on tax rates and the effects on your monthly paycheck, also contained within the new tax bill are provisions that will fundamentally change how alimony is treated for tax purposes throughout the country.
The New Law Changes How Alimony Is Treated for Tax Purposes
As it relates to the payment and receipt of alimony, prior to the enactment of this new tax law, the party paying alimony was entitled to deduct their payments from their tax liabilities, while the party receiving the alimony payment would end up paying taxes on their alimony as a form of income. This, however, has been turned on its head by the new tax law. Starting with alimony-related judgments after January 1, 2019, the spouse paying alimony will no longer be entitled to deduct those payment amounts from their overall tax liability, and the spouse receiving the alimony payments will no longer have to pay taxes on their alimony payments.
The prior tax laws were seen by many divorce attorneys as a way to preserve more money for the divorcing parties, allocating tax liabilities between former spouses and helping each party to afford to live separately. There are now concerns that with the new tax laws set to take effect in less than a year that it will leave less money overall for the divorcing family.
To help explain the effect of the new law a little better, imagine that one spouse is paying alimony in the annual amount of $20,000. Under the old tax law, if the paying spouse were to pay and then deduct $20,000 per year in alimony, with their income being taxed at the federal rate of 33%, then the previous tax law’s deduction had the potential to save them about $6,600 per year. On the flip side of that equation, the party receiving the alimony payments of $20,000 per year, if taxed at a standard rate of 15%, would see them paying about $3,000 per year in taxes, rather than the $6,600 that the paying spouse would have incurred under their tax rate. As a result, under the old system, the parties would have saved about $3,600 between the two of them, providing the paying spouse a tax break that makes the payments more affordable. These same savings would not be seen under the new tax law due to the difference in the allocation of the tax liability.
Why Was a New Tax Law Introduced?
So why was the law changed and why did the folks in Washington think this was a good idea to change up the tax responsibilities as they relate to these alimony payments? In writing the new tax law, Congress has referred to the alimony deduction as a “divorce subsidy,” and it appears that part of their rationale was to try and close the gap in which it was seen that a divorced couple could often obtain a better tax result for alimony payments made between former spouses than a still-married couple could.
Additionally, by making the paying party pay the taxes on alimony payments, it would bring alimony payments in line with child support payments, which historically have not been tax-deductible for the payer or taxable for the recipient. Of course, another significant reason for the change is the government’s bottom line, as Congress’s nonpartisan Joint Committee on Taxation estimates that by repealing the alimony deduction, the government has the potential to add $6.9 billion in new tax revenue over 10 years.
Consult with a Tax Professional
During the course of your divorce, it is generally a good idea to consult with an independent tax professional to ensure you understand how taxes could impact your overall settlement agreement, and with these new tax laws ready to take effect, this will be become even more important.
If you have additional questions or concerns about your alimony requirements or the new tax law, it’s important to speak with an experienced family law attorney to discuss your specific case and circumstances.
Attorney Russell J. Frank is a partner at CPLS, P.A. and focuses his practice areas on family and marital law. Contact Attorney Frank today at [email protected] to discuss any family or marital legal issues you may be experiencing.
Thanks, good post. It’s important to detail what qualifies as a written instrument to get you in under the 12/13/18 deadline.
Under the Tax Cuts and Jobs Act of 2017 (TCJA), alimony will no longer be tax deductible to the payor and no longer tax includable to the payee effective 1/1/19. The law was a shock to many, particularly divorce lawyers, most of whom had gotten quite used to the way things had been for the last 75 years. There is a saving grace in the TCJA, however — qualifying agreements and modifications can be grandfathered into the old taxability treatment under certain conditions.
The biggest misconception, frequently repeated in the media, or ignored even by legal commentators, is that the qualifying instrument must be a final divorce judgment. It does not. You do not necessarily have to have a final divorce judgment by the end of the year to be grandfathered. Lawyers, who always prefer to be “better safe than sorry” may prefer to have a divorce judgment but, when you are fighting this issue out in December of this year without the luxury of time, it’s worthwhile to take a closer look at what is actually required.
Procrastinators rejoice! The TCJA continues the language from IRC s.71 regarding a “written instrument incident to divorce” and, presumably, all the case law from the past several decades regarding that phrase. So, basically, in many cases, all a couple may need to qualify for grandfathered alimony treatment is a contract by 12/31/18 between them that meets the definition of a “written instrument incident to divorce.” Preferably, you would want to execute the contract while a divorce is pending or imminent so that it can meet the “incident to divorce” requirement. (The “incident to divorce” requirement, by the way, is why prenuptial or postnuptial agreements likely would not be qualifying agreements.) In any event, a divorce judgment is not the only way to get the preferential treatment. Word of caution to do-it-yourselfers: don’t do this without lawyers! And for more guidance, these Tax Court cases should be a good start, Micek, T.C. Summ. Op. 2011-45, Leventhal, T.C. Memo. 2000-92.
The logic is flawed. Instead of having two married individuals living on one (or two) incomes and paying taxes accordingly, a divorce creates two households of single individuals, one of whom survives on the maintenance/alimony they receive and any income they have on their own to supplement that amount. The former couple does not make financial decisions together anymore nor do they enjoy the benefit of managing the costs for only one household. In addition, what if both parties go on to own a home? If the maintenance is not considered income for tax purposes, how is the mortgage interest and property tax treated? Would the recipient of alimony potentially receive an earned income credit? Is the deduction for these lost to both parties? How about the recipients ability to contribute to a retirement account? If the alimony is not treated as income, and the recipient has less than the $5k to $7k from their own earnings, how will they qualify to contribute to a Roth or Regular IRA? How will the recipient individual, who may be of advanced age, plan for retirement?
This tax law change increases tax income for the Federal government but it is a marriage/divorce penalty. It increases the likelihood of sustained animosity between the parting couple and puts the alimony recipient at a disadvantage financially since they potentially are not able to manage income (assuming the alimony base income) to take advantage of the tax laws regarding deductions and credits that every single person and married couple has access to.
The only potential advantage I see is if the recipient has large medical bills, then those may be fully deductible but from what? Again, would that person receive a tax credit.
This was a stupid, illogical, ill-conceived and thoughtless change to how maintenance/alimony is handled for tax purposes. The only one who may benefit is an uber rich ex-spouse receiving alimony (who has retirement handled) and of course the Federal government.