The Tax Cuts and Jobs Act of 2017 introduced a myriad of changes to tax law as we knew it; Some beneficial, and others not so much. One of those changes was to the way we treat alimony payments for tax purposes and it will affect a tremendous amount of divorcing Americans. Ending a marriage is hardly ever a good thing and it is always best to try and work things out cordially if possible; All parties can save time, money, relationships, and stress! If divorce is a must, alimony usually rears its ugly head and therefore it is important to understand the concepts to follow.
This change officially went into effect January 1st, 2019. This means that if you have already been paying or receiving alimony due to a divorce dissolution, or at least had a court order finished by December 31st, 2018, this change does not pertain to you. The alimony agreement needed to be in a final settlement or court order by year end 2018 (not a temporary agreement) – in order to maintain the deduction going forward.1 Only divorce settlements that are finalized on or after January 1st, 2019 will fall under the new regulation. Any modifications to current dissolution agreements after January 1st, 2019 will need to be carefully reviewed by your attorney and may also become subject to the new law if changed.
For literally decades the payor of alimony (usually the breadwinner in the situation) was able to deduct 100% of the payments to the ex-spouse on their personal tax returns. On the other hand, those receiving alimony payments or "payees" had to report the payments as income on their tax returns. This meant that the payee (often in a lower tax bracket) paid the income tax. Under the new tax law (agreements made after January 1st, 2019), the payor of alimony can no longer deduct their payments and the payee no longer includes the payments as taxable income. Sounds like a huge win for those receiving payments right? Not necessarily. What this likely means is that the alimony to be paid is taxed at a higher rate; which in-turn leaves less money "in the pot" to go-round for both spouses. Therefore under these new rules it seems to be a lose-lose when compared to the old rules.
Unlike the majority of changes to the tax law, the new alimony rules do not automatically sunset (go away) in 2025. They are permanent unless there is an entirely new tax overhaul that says otherwise.
Note that deductible alimony payments are an "above-the-line deduction", which in effect can help you get additional deductions elsewhere on your return. Above-the-line deductions also have no effect on whether you "itemize deductions" or use the "standard deduction". Why is this relevant? The new tax laws increased the standard deduction fairly significantly and on the other end capped certain itemized deductions. Therefore, there will likely be a higher percentage of Americans (divorced or not) utilizing the standard deduction until these changes sunset in 2025. Going forward, if you have a pre-2019 agreement you can still deduct 100% of alimony payments and also take the standard deduction if best (could be a win-win).
Alimony payments to a payee that are included in income (pre-2019 agreements or "old laws") are also considered "earned income" for IRA and other retirement plan contribution purposes. However if you get a divorce under the new laws, you won't be reporting the payments as income and therefore there will be no more "earned income" from alimony payments alone. If alimony would be your only source of income post divorce, consider this factor in your financial negotiations during the divorce process. This can affect what assets are to be split and alimony to be agreed upon if any. This is especially important for rather wealthy individuals or those where one spouse generated all of the household income.
Choosing to pay alimony via a blend of cash and retirement funds may be a way to minimize alimony. Paying alimony with pre-tax dollars from a retirement account could end up netting you the same benefits that were available under the previous law. These types of payments need to be done very carefully and in a specific fashion. See here (IRA, Retirement Accounts) for more details on how to go about these strategies.
For families with a substantial amount of assets such as investments accounts, retirement accounts, real estate, and businesses there will be more planning opportunities available. There may be ways to split assets in non-traditional ways in order to minimize any potential alimony or eliminate the need completely. For families with a relatively small amount of assets, alimony may still be necessary. There will be a good amount of planning to do with your advisor and counsel.
The general rule is that spousal support payments (alimony) are not dischargeable in a bankruptcy; Whereas other assets or property used to make payments may potentially be discharged if the payor files bankruptcy.
Other than alimony, there are other tax changes and limitations in the Tax Cuts and Jobs Act that can play a key role in how you negotiate your divorce dissolution. Keep this in mind when talking with your advisors and counsel.
The Bottom Line
Navigating transitions like divorce is difficult, there's a reason why us financial planners, CPAs, and family law attorneys exist. I believe your best option financially and emotionally will be to negotiate cordially with your soon to be ex-spouse. Come to an agreement among yourselves if possible or seek mediation. If all else fails or your financial matters are far too complicated, seek professional help. It will likely cost you much less in the long-run, and give you the resolution you'll need.
This material was created to provide accurate and reliable information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice.The services of an appropriate professional should be sought regarding your individual situation. 04/19