Learn about the new tax treatment of alimony and other considerations.
- The new tax act changes the tax treatment of alimony for both the payer and the recipient.
- For divorces finalized prior to January 1, 2019, this new tax treatment will not apply and will be grandfathered under the rules of the prior law.
- It is important to review your settlement agreement in light of these tax law changes, and consider modification of an existing agreement if appropriate.
The Tax Cuts and Jobs Act of 2017 represents the most significant overhaul of federal tax law in over thirty years. The new tax law is sweeping in its reach, and divorce situations are not immune from its influence.
Prior to the enactment of the new tax law, spousal support payments that qualified as alimony were characterized as taxable income to the recipient and deductible by the payer. Under the new tax law, alimony payments made pursuant to a divorce instrument finalized (or modified) after December 31, 2018 are no longer treated as taxable income to the recipient, and alimony payments cannot be deductible by the payer. The federal income tax treatment of alimony payments made pursuant to a divorce instrument finalized prior to January 1, 2019, will be grandfathered under the rules of the prior law.
Divorcing spouses will have the opportunity during the balance of 2018 to either finalize their divorce prior to the end of 2018 (if they wish to have the prior income and deduction rules apply to alimony payments) or plan accordingly under the new federal tax law as they settle the terms of their divorce after 2018.
Of course, as with many of the changes in the individual income tax provisions of the federal tax law, this provision is set to sunset at the end of 2025, at which time the law in effect prior to the Tax Cuts and Jobs Act of 2017 will return, absent additional legislation prior to then.
In addition to potentially changing the manner in which property settlement agreements are reached by divorcing spouses and their advisors, the net effect of this change in the tax law is that the de facto shifting of tax brackets (i.e., lower income taxes paid) will no longer occur. Beginning with divorces finalized (or modified) on or after January 1, 2019, the presumed higher tax-bracket spouse will lose an often significant deduction, and will no longer be able to shift a portion of his or her income tax burden to the presumed lower tax-bracket spouse.
Other changes in the federal tax law will also have an impact in divorce matters and may be worth considering, either prospectively or if former spouses decide to revisit a divorce agreement already in place:
- Personal exemption has been eliminated: Before 2018, the exemption per child could only be taken by one parent. The new law eliminates personal exemptions for dependents after 2017, until the provision sunsets after 2025. If this tax benefit was part of a settlement agreement negotiated before the benefit was eliminated, impacted taxpayers should consider the effect of its elimination.
- Limitations on/elimination of deductions (such as professional advisor fees): The professional fees paid during the course of a divorce can be substantial. The inability to deduct such fees should be factored in by divorcing parties as they negotiate the property settlement agreement.
- Decreased corporate tax rates: The lowering of federal income tax rates applicable to corporations could result in higher business valuations for closely held businesses, which are often a component of property settlement agreements. The higher the percentage of a divorcing couple’s net worth that is represented by less liquid and harder to split business interests, the greater the strain on the more liquid assets.
- Education expenses: The new tax law now allows for distributions from 529 Plans to be used for qualified education expenses, not only for college, but also for tuition expenses for elementary, middle, and high school (up to $10,000 per year). Divorce instruments often address responsibility for maintaining assets for payment of education expenses. Agreements already in effect may need to be re-examined to be sure that both parents are aligned as to funding and purposes of, and distributions from, these established education accounts.
- Child tax credit: The annual child tax credit, which is typically available to the custodial parent, has been increased from $1,000 to $2,000. Existing divorce instruments should be reviewed to determine if the new tax law merits consideration of possible modification.
Divorcing spouses and their advisors should be aware how the new tax law will impact divorce settlements moving forward. Further, taxpayers should review with their advisors any existing pre-nuptial, post-nuptial, and property settlement agreements, or other marital or divorce agreements, to understand the impact of the new tax law and to also consider whether possible modification under the new federal tax system is desirable and appropriate.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, while this publication is not intended to provide tax advice, in the event that any information contained in this publication is construed to be tax advice, the information was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any matters addressed herein.Download Article