The new Tax Cuts and Jobs Act repeals the deduction for alimony payments after 2018. The United States Internal Revenue Code previously provided that the spouse paying alimony could deduct the alimony paid from his or her taxes, and the payee spouse had to pay income taxes on the alimony received. Pursuant to the new Act, alimony payments pursuant to agreements executed in 2019 or later would not be deductible by the payor or includible in the income of the payee. The reason stated by the official Section-By-Section Summary of the Ways and Means Committee Majority Tax Staff (the “Staff”) for the change is to “eliminate what is effectively a ‘divorce subsidy’ under current law, in that a divorced couple can often achieve a better tax result for payments between them than a married couple can.” The policy being enacted by this change, according to the Staff, is “that the provision of spousal support as a consequence of a divorce or separation should have the same tax treatment as the provision of spousal support within the context of a married couple . . . ” Rather than debate the actual policy, this article discusses its effect on taxation, as well as important takeaways regarding its effect on the divorce settlement process.
The first takeaway from the new law is that it would not change any pre-existing marital dissolution agreements executed prior to January 1, 2019. The original house bill had this change come into effect for any divorce or separation instrument executed in 2018. However, the conference agreement (as stated in H. Rept. 115-466) changed the effective date to encompass any divorce or separation instruments executed in 2019, thereby delaying this change for one year. Agreements executed in 2018 and before will continue to be taxed the same way they always have. However, agreements executed in 2018 will want to include the following language to ensure the tax deduction applies: “[t]he parties have agreed that this provision regarding the taxability and deductibility of this alimony shall continue beyond December 31, 2018.” However, for any agreements in 2019 and beyond, the economics of divorce settlements will change. For agreements entered into after January 1, 2019, the person paying the alimony will no longer be able to deduct it from their gross income, and the person receiving the alimony will not include it in their income.
This change is significant, because generally the former spouse paying the alimony has a higher income and therefore is paying taxes at a higher rate. Couples then who have already firmly made the decision to divorce would likely benefit from reaching a settlement agreement in 2018, if alimony is going to be part of the plan. For example, a single person with an income over $200,000 (and below $500,000) would be taxed at 35%, whereas a single person with an income over $38,700 (and below $82,500) would be taxed at only 22%. If the payor spouse in the 35% tax bracket pays and deducts $40,000 per year in alimony, the deduction would save him or her $14,000 per year. The payee spouse in the lower tax bracket currently pays income taxes on the alimony received at a lower rate. Accordingly, the tax deduction for alimony payments saved money between the parties.
For years, family law attorneys have negotiated divorce settlements with tax implications in mind. The elimination of the alimony deduction will likely have a substantial impact on divorce settlement negotiations in alimony cases. The tax deductibility of alimony was helpful in settling divorces as it created an incentive for spouses to pay more alimony to support his or her former spouse.
While multiple factors are considered when determining an alimony obligation, two significant factors are the need of the financially disadvantaged spouse and the obligor spouse’s ability to pay. The new tax law reduces the payor spouse’s ability to pay by requiring him or her to pay tax on alimony, thus, generating additional tax revenue. As a consequence, less money will be available to alleviate the need of the payee, and the payor spouse will have a stronger argument for a lower alimony obligation. Even though the spouse receiving alimony will no longer be required to declare the alimony payments as income for tax purposes, less money will be available between the parties due to the alimony payments being taxed to the payor spouse at the higher tax rate versus the payee spouse at a lower tax rate. Thus, the new tax law will likely lead to a reduction in the amount of alimony awarded. Accordingly, it is imperative for family law attorneys to consider these changes when reviewing or relying on prior alimony obligations ordered in cases with similar facts, but under prior tax law.
Finally, another important issue to consider is that under the prior law (i.e., before 2018) separately stated attorney’s fees incurred for the purposes of obtaining alimony could be deductible (and similarly tax advice could be deducted as well), provided that the client itemized his or her deductions on Schedule A (and provided that the total miscellaneous itemized deductions exceeded 2% of the client’s adjusted gross income). The Tax Cuts and Jobs Act suspends miscellaneous itemized deductions, so this legal and tax expense is no longer deductible.