Understanding Alimony Deductions
Under current tax law, alimony payments are deductible to the individual paying the alimony and reported as taxable income by the recipient (unless the divorce decree or separation agreement stipulates otherwise).
In practice, this tax treatment often generated tax savings for a divorced couple, as the payor of the alimony (who received the deduction) was typically the higher income spouse (in a higher tax bracket), while the alimony recipient was typically the lower income spouse (in a lower tax bracket). Transferring income from the higher tax bracket to the lower also allows for some creativity in settling cases and to allow a Certified Divorce Financial Analyst to expand the pie before dividing it up by minimizing tax liability.
The new law
The Tax Cuts and Jobs Act (TCJA) legislation announced this week would eliminate the alimony tax deduction for the payor and make the alimony payments received tax free to the recipient, effectively eliminating the tax bracket arbitrage between the divorced spouses’ tax brackets and render other tax codes like alimony recapture and child contingency rules obsolete.
It is important to note, this change in the treatment of alimony would only apply to new alimony agreements entered into after 2017. Existing alimony agreements and court orders would not be altered unless the couple expressly modified an existing divorce decree or separation agreement to change the treatment after 2017.
Many people who have read the bill think there is a very good chance it will pass and become law very close to its current form. From our perspective, this law will take away one great financial benefit of post-divorce life.
What does it mean for you? If you are currently in the middle of divorce proceedings you should consider the effect the rule change will have on you long term whether you are the payer or recipient. It will also require many states to revisit their guideline formulas for determining alimony and even re-write the code underlying computer programs used to calculate the guidelines.
Remember this bill has not become law as of writing this post but beware of the pending change and check back as we get more information.
Wellspring Divorce Advisors helps individuals and couples address the financial aspects of divorce in a civilized, equitable, and efficient manner by providing expert divorce financial planning and advice.
Contact us to find out how we can help you through this process.