Tax implications must be considered when contemplating the finances of a divorce. Currently, alimony is generally an “above the line” deduction for an alimony payor (the person paying) and is included as income for the payee (recipient of) alimony, subject, of course, to certain limitations (for example, the parties must file separate returns, live separately, etc.).
Changes to this law will go in effect beginning January 1, 2019, at which time alimony will no longer be tax deductible for the payor or includable as income to the payee. Alimony will work like child support, it will not be part of taxable income to the recipient, which means that the person paying cannot deduct it from his or her income. 600,000 people currently use the alimony deduction and 800,000 couples divorce each year, so the impact of this law will be widespread. It is important to note that this law is not in effect yet, and alimony payments will still be deductible for any divorces finalized prior to January 1, 2019.
Say the alimony payor makes $300,000 and is in the 25% tax bracket (we are using round/general numbers for the sake of example). Say the payor pays the ex-spouse $90,000 per year in alimony. This makes the payor’s taxable income $210,000 per year- 25% being $52,500 year in taxes. Meanwhile, the payee is paying taxes on the $90,000 being received in alimony. Under the new law, the payor would pay taxes on the full $300,000 BEFORE deducting the $90,000 in alimony- 25% being $75,000 per year in taxes.
We believe that there will be changes in the way that alimony awards are negotiated. Because the alimony payee will be receiving a post-tax award, it is likely that agreed-upon amounts will naturally be lower than what we have seen in the past, to account for the tax adjustments. It is unknown whether judges will take the tax implications of alimony into account when ordering an award, but it seems that, in the interest of equity, they would be cognizant of these changes as well.
If you are contemplating a divorce and feel that you may be paying alimony to your spouse, it may be wise to try to finish your case before the end of 2018 to be sure that you can deduct any alimony payments. If you feel you may be the recipient of alimony, some may argue it could be worthwhile to wait until after the end of 2018 to ensure a post-tax alimony payment. However, additional food for thought may be how the new law will impact the actual amounts of alimony awards, for example, in 2019, will alimony obligations trend downward? Only time will tell. Alimony reform has been a hot-button issue for many years and we forecast that more changes could be coming our way in the future. We will keep you posted!