How The New Tax Law Affects Alimony
In this article, we’ll explore the new tax law’s affect on alimony, when the changes take effect, and how this will impact alimony cases.
Overview of New Tax Law’s Effect On Alimony
Prior to the new tax laws, the spouse paying alimony could deduct any alimony actually paid during the tax year (so long as certain other criteria were met). The alimony recipient was responsible for reporting the alimony they received as income.
Congress has now eliminated the alimony deduction starting in 2019. These changes sent shockwaves through the family law community.
Why The Change
The simple answer is it gives the government more money.
The alimony payor is almost universally in a higher tax bracket than the alimony recipient. Under the old tax regime, the government collected taxes at the recipient’s lower tax rate, instead of the payor’s higher rate.
As a rudimentary example, take a party paying alimony of $2,000 per month who is in the 33% tax bracket. Assume the spouse receiving the alimony is in the 25% tax bracket. (For purposes of the example we’ll stick with simple brackets and not get into the details of effective tax rates.) The alimony payor would otherwise be paying $660 of the $2,000 per month to the government. Instead, the alimony recipient is only paying $300. The government was losing $360 in taxes every month on these ex-spouses.
This may not seem like much in isolation, but Investor’s Business Daily reported that in 2015 nearly 600,000 people claimed the alimony deduction for a total of $12.3 billion in tax deductions.
When Do The Changes Take Effect
The new law affects “any divorce or separation instrument…executed after December 31, 2018.”
So must a divorce must be finalized by the end of 2018 or is it enough to have an executed settlement agreement which will later be finalized into a divorce decree?
26 U.S. Code § 71(b)(2) defines a “divorce or separation instrument” as either:
- A decree of divorce or separate maintenance or a written instrument incident to such a decree; or
- A written separation agreement; or
- A decree requiring a spouse to make payments for the support or maintenance of the other spouse.
Thus, any agreement executed before 2019 continues to be operate under the prior tax laws. Alimony remains deductible even if the divorce isn’t finalized by a court order or final decree until after December 31, 2018.
The Changes Only Affect Modifications If Expressly Provided
The new tax laws also affect previously executed divorce orders which are modified after December 31, 2018, but only if the modification expressly provides that the new laws will apply. The alimony modification will continue to operate under the old tax laws unless language is added to the modification order stating that the TCJA applies.
It remains to be seen how state legislatures and courts will handle this issue. Will the court have the discretion as to whether to subject the modification to the new laws? Will modifications be automatically exempted from the new laws unless the parties otherwise agree? Or will the flip-side occur – where all alimony modifications are de facto governed by the new tax laws.
Alternative Tax Agreements Do Not Appear Permissible
Under the old tax regime, parties could agree that the alimony would not be deductible. The government was fine with this. As we’ve seen, the spouse paying alimony usually falls into a higher tax bracket. This meant the government was receiving more taxable income if the parties reached this type of agreement.
Under the new tax laws, though, the reverse does not seem to be the case. It does not appear that parties can agree to operate under the old system of taxation, allowing the payor to deduct the alimony and the recipient to claim the alimony as income. After all, this would mean less money in the government’s pocket.
How The Changes Will Affect Divorcing Parties, Settlement Negotiations, and Courts
The new tax treatment of alimony has the potential to cause significant changes in settlement negotiations. In my experience, this will have a greater psychological impact on the alimony payor than on the alimony recipient.
In settlement negotiations, it is much more common for the bread-winning spouse to swallow the thought of paying alimony when they factor in the deduction that was previously available. Instead of seeing it as a $2,000 per month alimony obligation, they’re more likely to view it as a $1,340 obligation. On the other side, it’s more rare to see an alimony recipient thinking of their post-tax alimony amount when negotiating. They’re more likely to view it as $2,000 per month instead of $1,700 after tax.
Now that alimony is a non-taxable event more creative property division will begin to take place. Instead of an oversized alimony award, a more reasonable amount may be considered along with an extra slice of a brokerage account or a greater share of the house sale proceeds. Income may be seen as simply another asset to divide instead of an issue separate and apart from property division.
It will also be interesting to see how courts and judges adjust to the new tax laws. Is this something they will take into account, or will their consideration continue to be the same? As an attorney, I would present the judge with a comparison between the old tax laws and the new.
How Should Divorcing Parties Handle The Changes
In going through a divorce, this only changes the rules, not what your perspective should be. As always in the divorce process, my advice is to focus on what you can control. You cannot control what the government does or what the IRS laws and regulations are, so don’t fret. The alimony negotiation paradigm has shifted, but the thought process should not. Focus on how much alimony you actually need or how much you can actually pay. Then work diligently toward achieving that figure.