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Tax changes affecting divorce settlements are set to take effect January 1, 2019, and some divorcees may be singing a modification of an old country tune, "My spouse got the gold mine, and I got the shaft."
Alimony Changes Due to TCJA
For those high income earners who are contemplating divorce, knowing they will owe alimony, you might want to get that divorce finalized before New Year's Eve. The 2018 Tax Cuts and Jobs Act (TCJA) made numerous changes to the tax laws, and one of them deals with alimony.
For the last 75 or so years, alimony payments had been a tax deduction for the one paying, and taxable income for the one receiving. But no more! For all divorce decrees finalized or modified January 1, 2019 and beyond, those that pay alimony will have to pay taxes on all of their earned money, and those receiving the alimony won't have to pay taxes on the alimony received. Basically the new law states that alimony is not a taxable event. Confused? Here's an example:
Alimony and Taxes: Traditional vs. TCJA
Let's say spouses divorce in 2017. Spouse A makes $250,000, and Spouse B makes $50,000. In the divorce agreement, ex-Spouse A must pay ex-Spouse B $50,000 each year. When it comes time to pay taxes, A would pay taxes on a gross income of $200,000, B on $100,000. But now that's about to change. Take that same couple, divorcing in 2019. Taxes are paid on just the earnings, without taking the alimony into effect. A would pay taxes on $250,000, and B would pay taxes on $50,000. Imagine how A feels, making $250,000, losing a chunk of it to taxes, and then losing another $50,000 to alimony. The A's of the world will feel like they are getting the shaft, and therein lies the problem.
This new tax law stands to make an acrimonious situation even worse. Well, worse for some, since B gets to keep about another $11,350 that would have gone to federal taxes.
Is Ex-Spouse B Really Getting the Gold Mine?
But who is really getting the gold mine in this situation? It may be the federal government. A, as a higher breadwinner, is taxed at a higher percent than B in all formulas. So taxing more of A's money is a boon to the IRS! Given that about 20 percent of the 600,000 taxpayers who currently claim the deduction are in the top 5 percent of household income earners, we are talking a big boon. In fact, the Joint Committee on Taxation estimates this tax change will increase federal tax revenues by $7 billion over the course of a decade. Note that this provision is not one that sunsets in 2025, so the federal government could be seeing dollar signs for years to come on this change.
If you are contemplating divorce, you may want to talk with either your divorce or tax attorney about finalizing before New Year's Eve. With the savings, you could throw one heck of a party! If not, make sure that your attorney negotiates new alimony figures, in light of this upcoming change.