On December 31st, 2018, a 75-year-old tax provision benefitting divorced couples will be chucked out the window thanks to the Tax Cuts and Jobs Act. On the face of it, this is bad news for better-off spouses who currently receive tax deductions on alimony payments and good news for those receiving alimony, as they will no longer have to pay taxes on the extra cash. As a result, couples who are in the midst of an ongoing divorce are even more divided, with one party seeking to expedite mediation proceedings and the other party looking to slow down the process as much as possible.
Lester Barclay, of the Barclay Law Group in Chicago, depicted the scene as it stands in the wake of the Republican overhaul of the US tax code. “Both lawyers and litigants are aware of the deadline and are gearing up,” he said. “There’s going to be a lot more litigation and a lot more fighting.”
No Longer Mutually Beneficial
What was once a trade-off is now a one-sided affair, with the higher-earning spouse having to fight for a lower pay-out. With the scales tipped, divorce proceedings could become more contentious than before. At least, under the current law, the better-off spouse is able to reap some small reward, even it is “a spoonful of sugar,” according to Rhonda de Freitas, of Chicago-Kent College of Law.
The Real Winners
There is, however, more than meets the eye. Under the new tax law, neither of the spouses comes out on top. The true champion turns out to be the federal government, which will rake in more tax revenue than before.
Here’s why: the current law allows one (better-off) partner to transfer income – which would be taxed at, say, the 35 percent bracket – to the lower-earning spouse, who may fall within the 15 percent tax bracket. De Freitas boiled it down to this: “The beauty of the deduction was the ability to float some income from one side of the family balance sheet to the other without Uncle Sam getting his hands on it.”
By contrast, under the Tax Cuts and Jobs Act, the higher-earning spouse will be incentivized to keep 35 percent more money on their side of the balance sheet – to offset the lack of deduction. As, in our example, the recipient falls within the 15 percent bracket, he or she will pay less in taxes but ultimately will lose money due to the 35 percent hit. Meanwhile, the government will get to keep 20 percent more of the alimony than before.
The Real Losers
As noted by ABA Journal, the new tax code, which will yield $6.9 billion for the US government, will ultimately hurt children and women, who make up 98 percent of alimony recipients. Higher-earning couples will barely feel the change, but working class families who are counting every cent will most assuredly feel the pain.
What This Means for You
What does this mean for couples in the midst of a divorce? Well, all divorce proceedings taking place prior to 2019 will follow the procedures that have been in place for three-quarters of a century. That means payers will be able to write-off alimony on their federal tax return, and payees will have to report alimony as taxable income. For payers to receive the tax benefits, they will have to meet certain tax-law requirements. As long as these requirements are met, the payer can deduct the alimony payment without having to itemize deductions. In some cases, alimony payments may not make the cut under tax-law definitions. In these circumstances, the funds may be deemed non-deductible personal expenses – meaning the payer receives no benefit and the payee pays no taxes.
To determine whether the alimony payment is defined as alimony under the tax code, there are a few criteria to consider.
- Most importantly, you must be certain that the divorce papers stipulate the payment of alimony.
- The payment must also be made to or on behalf of a spouse or ex-spouse. For instance, if a payment is made to a third-party, it may be deemed alimony, as long as the payment is made in accordance with the divorce agreement and on behalf of a spouse of ex-spouse.
- In addition, the payer and payee must live in separate houses and cannot file jointly.
- Relatedly, to declare a deduction, the payer must include the social security number of the payee on the federal tax return.
To re-iterate, once 2019 rolls around, payers will no longer receive benefits and payees will no longer have to pay taxes on alimony. This means potential payers in the midst of divorce proceedings will want to finalize their separation as soon as possible, while the payee will want to delay the proceedings in order to benefit from the tax cut.
These are a few of the primary considerations. For a more thorough account of the current and future tax code, it is advisable to seek the help of a skilled professional. Talk to a divorce lawyer in your area.
