Alimony, also known as spousal support or maintenance, is typically paid by the higher earning spouse following divorce. While some states still award lifetime alimony, it’s barred in others, so today, most alimony is rehabilitative and durational: paid for a set amount of time following divorce, or until the recipient remarries.
Recent tax reform changes have shaken up the divorce planning arena. The previous tax status for alimony (in place since 1942) is soon to reverse. If you’re wondering how new tax laws impact your existing or upcoming divorce settlement, SageVest Wealth Management has a number of answers for you.
Why Change How Alimony Is Taxed?
Because the person paying alimony is the higher earner, their taxes under the old tax laws were generally greater than the taxes paid by the receiving party. By transferring income to the alimony recipient, often subject to a lower tax bracket, the alimony structure often helped to reduce taxes owed at high tax brackets and transfer a portion of the tax “savings” to the alimony recipient. The recent tax changes to alimony payments were in part implemented to address this differential and generate higher tax revenue.
While this change is anticipated to result in higher tax revenue, it sadly also results in less net income between the two ex-spouses, making divorce more financially difficult, particularly for families with children and for the receiving spouse.
Does Tax Reform Affect My Alimony?
Whether tax reform affects your alimony depends primarily upon when you get divorced or enter into a marital settlement agreement. The new tax reforms apply only to agreements executed, or divorces finalized, after December 31, 2018.
If you have an existing divorce agreement and are considering a modification in 2019 or after, you should seek legal and tax advice regarding tax treatment of any such modifications. The manner in which your agreement is modified could dictate the future tax treatment.
Sarah Zimmerman, a partner in the Family Law Group at Feldesman Tucker Leifer Fidell, urges clients who are considering separation or divorce to immediately contact both their tax preparer as well as a divorce lawyer: “Anyone contemplating separation or divorce should determine as soon as possible whether entering into a marital settlement agreement (or completing divorce proceedings) prior to the end of 2018 would result in significant tax savings that will be unavailable once the new tax laws take effect in 2019. It is also critical to determine whether finalizing an agreement or obtaining a divorce before December 31st is even possible.”
What To Do If You’re The One Paying Alimony
From January 1, 2019, alimony will no longer be tax-deductible. This loss may impact how much alimony you can afford or are willing to pay.
Example: Under the old scheme, if you paid $60,000 in alimony and your effective tax rate was approximately 30%, it would actually cost only approximately $40,000 for you to provide $60,000 in alimony to your former spouse. However, under the new laws, you won’t get any tax deductions and may not be able to afford (or desire) to pay the full $60,000 without such savings.
Furthermore, some states embed alimony guidelines in state law. Until laws are updated, those states may continue referencing previous tax law calculations when assessing alimony, potentially causing you a double inequity.
If you’re the higher taxpayer in a divorcing couple, your tax preparer and divorce lawyer should work together to review your options. It may benefit you to enter an agreement before December 31, 2018.
According to divorce attorney, Sarah Zimmerman, “reaching divorce settlements in 2019 and thereafter, when spouses paying alimony no longer have the benefit of a tax deduction, will likely be much more difficult because less net income is available for alimony. If at all possible, parties should attempt to enter into an agreement before the end of 2018 so that the lower-earning spouse and any children can receive the benefit of any tax savings instead of such amounts being lost and instead paid to the IRS.”
What To Do If You’re The One Receiving Alimony
Changes to alimony taxation may positively impact you as follows:
- Your alimony will not be assessed as taxable income if you enter into an agreement or divorce after December 31, 2018.
- If your ex-partner is incentivized to settle before year-end, you may be able to negotiate a better deal.
However, there are also some potential downsides:
- Your ex will no longer be able to claim a tax deduction for any alimony paid to you and may offer reduced alimony payments as a result.
- It’s possible that your divorce could become more acrimonious if you can’t agree how to make the new tax reforms work for both of you.
- If you’re the lower income partner with kids, or you stayed home to raise a family, you’re likely to be hardest hit by these changes.
If you anticipate being the recipient of alimony payments, you should consult a divorce lawyer and your tax preparer to determine whether it’s in your best interests to enter into an agreement or finalize your divorce before December 31, 2018, or delay your divorce settlement into 2019.
What To Do If You’re Considering Divorce
For couples with a significant difference in tax rates between the higher and lower earner, establishing an alimony agreement or finalizing your divorce during 2018 could be a valuable tax-planning opportunity, with tax savings being equitably distributed between both parties, and possibly more resources available from such tax savings to support children and family needs.
There’s still time for you to negotiate before the new tax laws take effect on January 1, 2019. However, plan now, as divorce lawyers anticipate a surge in clients as the year progresses.
What About Child Support Payments?
Child support is separate from spousal support. Under the new tax laws, it remains non-taxable and non-deductible. However, because it’s based on gross income and it takes into account the amount of tax-deductible alimony, it remains to be seen how the different jurisdictions will alter their child support calculations.
Thoughts On How Tax Reform Affects Your Alimony
Even if you have no intention of divorcing, the tax reforms may still impact you if you have a prenuptial agreement. If so, you may need to update your prenup to take into account the new tax legislation eliminating tax-deductible alimony.
According to FTLF’s Sarah Zimmerman, parties who entered into a prenuptial agreement that contemplated alimony in the event of separation or divorce may not have anticipated that alimony would no longer be deductible. “Unfortunately, this is the time to dust off your prenuptial agreement and consult with your family law attorney, before the tax change takes effect, to determine whether your agreement needs to be revised or adjusted given that future alimony pursuant to the prenup will not be deductible. Given these game-changing amendments, it’s better to look and potentially review your prenuptial agreement now – when there is hopefully no acrimony between you and your spouse – rather than waiting for this issue to come up at the time of separation, when you and your spouse may no longer be on good terms.”
Reportedly, another reason for these alimony tax updates was the discrepancy on Federal income tax returns between alimony reported versus alimony received. It’s expected that the IRS will be focusing on these figures, especially during the transitional period, to ensure that the two amounts tally.
The road of life is not without its speed bumps. If you’re facing divorce, please contact us. Our services include financial planning and investment management services that incorporate the totality of your wealth, including tax strategies, into a personalized financial plan for your future financial success.