Alimony and Taxes
Federal lawmakers dramatically changed the tax treatment of alimony with the passage of a massive tax reform law in 2018. While the rule for decades before that had been that a person paying alimony was entitled to a federal income tax deduction, Congress scrapped the deduction, beginning for couples who divorce in 2019.
Broadly speaking, the federal government now takes a bigger chunk of taxes from a divorced couple than it used to, significantly changing the alimony and taxes dynamic. Many divorce lawyers believe that the change makes it more difficult to negotiate divorce agreements.
The Alimony Tax Rule
The change went into effect January 1, 2019. For divorces after this date, the alimony payer can't take a federal income tax deduction for the payments. The alimony recipient doesn't have to pay federal income taxes on them.
The rule doesn't apply to everybody. Couples are grandfathered into the old rule if they divorced or signed a separation agreement before January 1, 2019. For them, the alimony payer can take a federal income tax deduction, and can do this for as many years as the alimony payments continue. However, the payments are treated as income of the recipient spouse.
What It Means for Alimony Recipients
The new rule is a mixture of pluses and minuses for alimony recipients. The good news is that they no longer have to pay taxes on the spousal support payments they receive. However, it may be more difficult for an alimony recipient to negotiate an advantageous settlement or obtain a favorable court order, because the rule leaves the divorced couple with fewer dollars between them.
In other words, there is less money to go around because having the deduction usually resulted in a net tax savings for the divorced couple.
Want to see the math? Consider a spouse who pays $30,000 in alimony and whose income is taxed at 32 percent. A tax deduction would save this spouse almost $10,000 in taxes. Even if the other spouse had to pay income taxes on the alimony at 22 percent, the divorced couple would end up more than $3,000 ahead.
This was how things worked under the old rule.
Because Congress has seen fit to eliminate the alimony tax deduction, creative accountants look for loopholes. Some experts have suggested that it may be possible to blunt the effect of having no alimony deduction by making spousal support payments from an individual retirement account, or IRA.
We've been talking here about federal income tax. Alimony may be treated differently on your state tax return.
Grandfathered Couples Beware
If you divorced before 2019, consider yourself lucky from a tax standpoint. Also, be extremely cautious about modifying your spousal support agreement! You wouldn't want to accidentally lose your alimony tax deduction, which could happen if the modification is done sloppily. Before making changes to a pre-2019 agreement, it is advisable to consult an attorney with expertise in tax matters.
Of course, even if you are grandfathered, you won't qualify for an alimony deduction unless you meet all the requirements mandated by the Internal Revenue Service, including:
- You don't file a joint return with your former spouse;
- Your alimony payment is in cash (including checks or money orders);
- The divorce or separation agreement doesn't say the payment isn't alimony;
- Your payment isn't treated as child support or a property settlement;
- If legally separated under a decree of divorce or separate maintenance, you and your former spouse are not members of the same household when you make the payment.
Problems with Alimony and Taxes? Get a Lawyer's Help Today
Both taxes and divorce are complicated subjects, and when they are mixed together it can get even more confusing. If you have questions about alimony and taxes, it's a good idea to contact a local divorce attorney to discuss your specific situation and receive personalized legal advice.