Are you in the process of a divorce, or considering revisions to a divorce agreement? Be aware that the recently enacted Tax Cuts and Jobs Act (TCJA) is bringing drastic changes to the tax treatment of alimony payments.
Current rules allow a deduction for alimony payments made pursuant to a divorce or separation agreement, and require the recipient to report the income on their return. This accomplishes shifting the income from the higher income individual (typically, the person paying the alimony) to the lower income person (the person receiving the alimony).
Those paying alimony have traditionally used this tax deduction to take some of the sting out of the payments. Alimony payments of $50,000 would mean a tax deduction for the same amount, making the net effect of the payments closer to around $37,500 for a taxpayer in the 25% tax bracket.
Lawmakers argued that this current method is a “divorce subsidy”, noting that there is less tax paid on these monies since they are taxed at the lower rate of the recipient. Still, the method seemed fair since the money was being taxed to the ultimate recipient.
For divorce or separation agreements that are dated after December 31, 2018, alimony payments are no longer deductible, and the recipient is not required to report the income. This is a drastic change and will surely have an effect on divorce negotiations going forward.
Alimony paid pursuant to agreements put in place on or before December 31, 2018 will be grandfathered in and still follow the old rules. The payor still deducts the payments and the recipient reports the alimony received as income.
Even for grandfathered agreements, you could still find yourself subject to the new rules if the agreement is modified after December 31, 2018. The modified agreement should specifically state that the TCJA applies to the amendments.
Be sure to check your state rules to see if they will conform to the new treatment. California, for example, has not conformed (as of now). This means that under the new rules, the payor will not deduct payments on their federal return, but will for California. And recipients will not report alimony income for federal, but will for California.
Keep in mind these changes only apply for agreements or amendments dated after December 31, 2018. If you are in the process of a divorce, be sure to speak with your advisors about the timing in relation to these new rules.