The new tax law changes have implications for alimony payments that could help or hurt your finances if you’re in a situation to pay or collect alimony (usually called “maintenance” in divorce agreements).
Should you get divorced right now, or should you wait? Chances are, if you are wrestling with this question, taxes may not be one of the primary reasons you are pondering your options. Divorce is complicated and nerve-wracking enough without having to also think about taxes, right? Considering some recent changes to the tax code, maybe you should consider the tax angle as well.
Ordinarily, I’d be reluctant to recommend anyone rush a serious and somber process like ending a marriage, but in this case, a little thoughtful expediency might save you some serious cash in the long run. Happily married and not even contemplating divorce? The new tax law might affect you, too, if you already have a prenuptial agreement in place.
As almost anyone will tell you, divorces and attorneys are not inexpensive; every dollar matters. In addition to attorney fees to get the deed done (undone?), ongoing costs often include years of alimony and child support payments. It is the treatment of alimony payments that has undergone some significant change.
If your divorce is finalized on or before December 31, 2018, nothing changes. Under the old tax rules, alimony payments are a tax deduction for the payor, and the alimony recipient must pay taxes on alimony dollars received (albeit at a usually lower rate than ordinary income). Child support payments are neither deductible nor taxable; they are considered a division of marital assets and that treatment will remain the same.
With the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), the tax treatment of alimony payments for divorces finalized in 2019 or later switches to the same treatment as that for child support payments. Under the new law, alimony payments will no longer be deductible for the payor, nor will they be taxed as income to the recipient.
Why this tax change matters
Whether you love or hate the new tax law likely depends on which side of the alimony transaction you find yourself and how quickly or slowly you can finalize your divorce proceedings.
If you’re the recipient
If you are the future recipient of alimony payments, this tax law change could be seen as good news. Depending upon how things are negotiated in your divorce, you could count on receiving a stream of tax-free alimony income from your ex as long as your divorce is finalized in 2019 or later. There is no incentive for you to hurry divorce proceedings along prior to the end of this year (2018). Why pay income taxes on that alimony income if you don’t have to?
If you’re the payor
As the future payor of alimony payments after your divorce is finalized, time is now your potential enemy. If you can negotiate your way to a finalized divorce no later than December 31, 2018, you get to keep the current tax deduction that is in place regarding your future alimony payments. Your ex, in this case, would also be responsible for paying income tax on those future payments. While you may be in a hurry to move things along, don’t be surprised if your ex (or your ex’s attorney) pushes back to delay things in order to make those alimony payments nontaxable.
On the other hand, you (or your attorney) may be able to negotiate lower alimony payments in light of the fact that you will not be able to deduct these payments under the new tax law.
You both might be losing out
Many divorce attorneys see this tax law change as a net loss to both sides of the divorce. Under the old law, a high-income spouse may find it attractive to offer a higher amount of tax deductible alimony that results in a net lower after-tax payment for them. Subsequently, the alimony recipient is often in a lower income tax bracket and also pockets more after-tax dollars, even after paying income tax on the alimony received.
Under the new law, there is more incentive now for payors to negotiate a lower amount of nondeductible alimony, which may also lead to less net alimony for the recipient, even if the alimony can now be received tax free. Your best bet: have a frank and detailed discussion with your divorce attorney and your tax professional to find out which divorce timing strategy may be the best fit for you.