A few things are certain when going through divorce, but the tax status of alimony payments was always a given. Alimony, which is support provided by one ex-spouse to the other after a divorce has been entered, has historically been deductible to the payor and includable as income for the payee. That is no longer permitted. On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act which took effect on January 1, 2018. The new law eliminates the tax deduction for alimony payments. As such, alimony payers will no longer be permitted to deduct alimony on their taxes.
The implications of the elimination of the alimony tax deduction are still unknown, but it is possible that it may mean reaching a divorce settlement will be much more difficult. Typically, the favorable tax status of alimony has been used as a bargaining chip in reaching an agreement. The payer, usually the higher-earning spouse, would be enticed by the fact that he (or she) was able to deduct the alimony amount from his taxable income, lowering the true cost of the payment. Now that bargaining chip is off the table.
The following illustrative example may be helpful: Pursuant to the parties’ Property Settlement Agreement, the husband is required to pay $3000.00 per month in alimony to his wife which is taxed at thirty-three percent (33%). In effect, the deduction at tax time reduces each of these payments to $2,000.00 (Husband’s true cost). Wife would pay tax on that $3000.00 as income, but in a lower income bracket of fifteen percent (15%), meaning she would owe $450.00 to the IRS and keep the remaining $2550.00. By eliminating the deduction, providing the same level of economic support will cost Husband an extra $1000.00. Wife gets the entire $3000.00 to spend.
In the above example, Husband will have to find an extra $1000.00 per month to maintain his monthly alimony obligation. Realistically, Husband probably does not have that extra money laying around, and he will unlikely agree to pay that much. Wife, on the other hand, may not be willing to agree to take anything less. Where does that leave the parties? A protracted legal process and more legal fees.
What will the courts do? Divorce resolutions are based on actual circumstances, and since there is only a finite amount of money in the pot, courts will likely take the tax consequences into consideration when awarding alimony.
It is important to keep in mind that the alimony deduction repeal affects divorces carried out after December 31, 2018. The new rule won’t affect anyone already paying alimony.
Please consult with OWM’s Family Law Attorneys regarding this issue and additional questions.
— Written by Melissa A. Iacobucci, Esq.