Alimony and the Tax Code Effective 1/1/19
By Joseph DeCusati, Managing Director, Valuation & Litigation Support
There has been much discussion about the material changes to business taxes affected by the Tax Cuts and Jobs Act of 2017 (TCJA). It is reasonable to anticipate that many people will look at ways to lawfully avoid paying taxes by taking advantage of new tax laws.
Somewhat overlooked in the discussion of TCJA are the changes it has made for family law. Specifically, TCJA will change the way alimony will be taxed. As expected, divorce lawyers and family law judges are also looking at lawful ways to adjust to the TCJA provisions relating to alimony.
Alimony, also known as spousal support, is payment from one spouse to another dependent spouse to help support and maintain a living standard during or after the divorce. The alimony payment can be a long-term obligation, so the award can be substantial. Therefore, the tax consequences may also be substantial.
Prior to TCJA, the alimony payor generally claimed an income tax deduction for alimony payment, and the alimony was taxed as income to the recipient. TCJA repealed this tax treatment of alimony. Those who pay alimony can no longer deduct alimony payments from their taxable income in accordance with IRS Code §215, and those who receive alimony do not have to include it in their taxable income in accordance with IRS Code §71. These changes are expected to completely change the way attorneys settle divorce cases as well as how the judges determine the appropriate award of alimony.
A pivotal date for these new alimony provisions is December 31, 2018. Most alimony agreements executed on or prior to December 31, 2018, will be grandfathered under prior tax rules. The new rules under TCJA will not affect alimony taxes for these individuals. Payors will still get a tax deduction, and recipients will be taxed on alimony as income.
Parties to an existing alimony agreement may modify their spousal support after December 31, 2018, to reflect the new federal law. They can choose to have spousal support payments become non-deductible to the payor and non-taxable to the recipient. The parties would need to specifically state in writing that the new law is to apply.
The TCJA provision on alimony will affect divorce and separation agreements signed after December 31, 2018, providing many parties with an incentive to finalize divorces quickly.
Prior to TCJA, many couples executed prenuptial agreements specifying that the payor can deduct alimony and the receiver will pay taxes. The law is uncertain as to the outcome and the legality of such provisions. It is unlikely that such prenuptial agreements will be protected by grandfathering in the former tax laws, when a divorce agreement is signed after December 31, 2018. If you do have a prenuptial agreement, you should consult an attorney to add language that accounts for the uncertainty. Alternatively, the attorney can modify the existing prenuptial agreement to account for the tax liability.