If you are considering divorce, you may wonder how the tax act of 2017 could affect your final agreement. Changes have been made in many areas including new tax brackets, modified deductions as well as significant corporate tax changes. A lesser known change is the tax treatment of alimony paid upon divorce.
What is Alimony?
Alimony, maintenance or spousal support (however it is described in your state) represents a payment from a higher-earning spouse to the other spouse for their support after a divorce.
How has Alimony Changed?
Decades ago, it was almost always paid from a husband to a wife for longer periods. In a very long divorce where the wife had no skills, it was sometimes ordered for life. More recently, it is paid from the higher-earning spouse regardless of gender. In addition, the time frame has shortened significantly considering the time needed for the receiving spouse to increase earning capacity through education or experience within a current job.
Changes in Comparing Spouses’ Fault
Until 1969, every state in the country considered the fault of each of the parties which affected property division and alimony payments. This could be abandonment, adultery, extreme cruelty, etc. Now, only approximately half the states take fault of the parties into consideration when determining whether to award alimony. Some states have a hybrid system where the parties may waive a waiting period if they agree to a no-fault divorce. The 2017 tax law did not impact the consideration of fault in alimony.
Alimony Deduction with the Prior Law
The change came from how the payments were treated as taxable income. Under the prior law, alimony, maintenance or spousal support (however it is described in your state) was deducted from the income of the higher-earning spouse and treated as the taxable income of the receiving spouse. By shifting the taxes to the person with the lower tax obligation, the couple paid fewer taxes overall. Our attorneys at Derr & Villarreal have helped couples divorcing couples find an agreed-upon amount of alimony where there was significant disparity in income so that as a couple, they paid less tax.
Here is an example of how it works. Bill is a sales manager who makes $320,000 and Amy is a librarian. They’ve been married for 32 years and have no children. Under the old law, if Bill paid Amy $5,000 per month in alimony, he could deduct $60,000 annually from his $320,000 annual income leaving adjusted gross income of $260,000. His federal tax would be approximately $62,000. If he didn’t deduct it, his federal tax would have been approximately $82,000, which is $20,000 federal tax savings! If Amy included the alimony in her income, her tax would be $15,000. If she didn’t include the alimony, her tax would be $2,000.
If Bill saves $20,000 and Amy pays an additional $13,000, Bill and Amy together save $7,000 in federal taxes that are never paid by either of them as shown in this table:
|Spouse||Federal Taxes paid if Bill Deducts Alimony||Federal Taxes paid if Bill does not Deduct Alimony||Taxes Saved|
|Taxes saved by deducting alimony||+$7,000|
Alimony with the Tax Deduction Eliminated
But under the new law, the government will receive more money from divorcing couples because alimony will no longer be deductible for parties who signed settlement agreements after January 1, 2019. In this new scenario, Bill could pay Amy $5,000 per month but without being able to deduct it, his total federal tax remains at $82,000. (This does not take into effect other tax changes in 2018 such as the elimination of the personal exemption or doubling of the standard deduction.)
The good news is that couples with significant earnings disparity who have decided to divorce can take advantage of the fact that all agreements signed before January 1, 2019 will allow the payer to deduct payments to the recipient.