By Shelby J. Anderson
On December 22, 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act. This bill amended the Internal Revenue Code and modified many policies and tax rates. Included in this Act is a change in who receives the tax deduction on alimony payments. Find out how this change will affect you.1
How Does the Tax Cuts and Jobs Act Affect Your Alimony?
Divorce can often increase financial stress due to increased financial burdens ̶ a divorcing couple must utilize the same income to cover the increased expenses of living as two individuals.
Alimony is a popular way to ease the financial burden of the lower earning spouse after divorce. Alimony (known as spousal maintenance in Arizona) is an allowance given to one spouse by the other spouse for support both pending and after a legal separation or divorce.2 The 75-year-old alimony tax deduction allowed the paying spouse to deduct alimony payments from their taxable income, which reduces his or her overall taxable income. The alimony deduction was one financial area where both spouses seemed to benefit, and it incentivized the higher wage earner to agree to larger alimony payments. Alimony is taxable to the receiving spouse, which means the spouse receiving the payments is required to report alimony payments as gross income.
Now, President Donald Trump’s tax code overhaul is changing the tax consequences of alimony.3 The Tax Cuts and Jobs Act repealed Internal Revenue Code Section 71 and related sections, which provided the alimony deduction to the payor spouse.4 For couples who divorce after the Act takes effect, the spouse paying alimony will be required to include alimony payments in their gross income. In other words, alimony will be taxable to the paying spouse and tax-free to the recipient spouse. The Act essentially shifts the tax burden from the recipient spouse to the payer spouse.5
This change will increase the total amount of tax paid by divorced couples. The spouse paying alimony has a higher income and a corresponding higher tax bracket and therefore will pay a higher tax on the alimony payments, leaving less money to the recipient spouse.6
Why did the Government Change the Recipient of the Alimony Deduction?
The House of Representatives Ways and Means Committee (the principal tax-writing committee) provided some explanation for the change. The Committee characterized the alimony deduction as a “divorce subsidy,” noting that divorced couples can achieve better tax results than a married couple.7 The Committee also reasoned that alimony should have similar tax consequences as child support, which is not reported on either party’s taxes.8 According to the Act’s bill summary, this change will provide the Federal Government with an additional $8.3 billion in taxes from divorced couples over the next 10 years.9 Another stated reason for this change is that it will be easier for the IRS to manage. Recent IRS data shows that alimony sometimes shows as deducted on the paying spouse’s return but is not reported as income by the recipient spouse, which results in a loss of tax revenue to the Federal Government.10
How Will This Change Affect You?
It is estimated that the new tax plan will reduce the total amount of spousal support that is paid out. With the current tax plan, the payer was incentivized to pay more alimony since the deduction lowered their taxable income. Further, the money is taxed at a significantly lower rate in the alimony recipient’s possession.11 This tends to preserve more money overall to allocate between spouses, helping them afford to live separately.12
Under the new plan, income used for alimony payments will be taxed in the bracket that applies to the payor spouse instead of the recipient spouse. Consequently, it is feared that higher-earning spouses will negotiate lower payments after January 1, 2019, when the alimony deduction is eliminated.13 It is estimated that future alimony recipients could lose 10 to 15 percent of alimony received under the current law.14 Because women receive up to 98% of all alimony payments, women will be more negatively impacted than men.15
Not every divorced couple will be subject to the new tax rules. Generally, divorcing couples with substantially equal incomes are not awarded alimony. Spouses divorced before December 31, 2018 will continue under the previous alimony tax rules.16 Further, if there is a pre-2019 divorce or separation decree and the ex-spouse wants to have the decree modified, the new tax rules do not apply to the modification unless it is expressly stated that the new rules are to apply.17
Is there Anything I can Do to Protect Myself?
There are some options available to spouses. Divorcing spouses can negotiate for a division of assets that would offset potential alimony payments. Prenuptial agreements are a tool couples can use now to control the amount of alimony payments. Because some prenuptial agreements have alimony provisions that assume the tax deduction for the payor, prenuptial agreements may need to be modified. A properly drafted prenuptial agreement can provide smaller payments, lump sum payments, or can eliminate spousal maintenance altogether in order to offset this tax burden. Couples can agree to a different division of assets in lieu of paying alimony. Arizona has adopted the Uniform Premarital Agreement Act, which allows parties to a premarital agreement to contract regarding financial and other matters. While a prenuptial agreement cannot decrease a spouse’s federal tax liability with an alimony award, a prenuptial or postnuptial agreement can provide for the recipient spouse in different ways than traditional alimony payments, which can save both spouses money.
These new tax rules go into effect in 2019. If you and your spouse have a prenuptial agreement, alimony payments, or are thinking of getting a divorce, you should consult with a family law attorney prior to taking any action in order to understand how this new alimony tax rule will affect you. Call DuMond & Doran today to schedule a consultation with one of our family law attorneys.