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Divorces are difficult, over all, but add to them the stress of trying to understand tax law, and the road ahead looks even darker. One bright spot in the tax laws (pre 2018) was that a tax benefit existed in cases involving alimony. Under the IRS tax rules before 2018, alimony was tax deductible the payor, while being taxable to the recipient. But this has changed under the Tax Cuts & Jobs Act of 2017.
Alimony and Taxes
The issue of alimony is more common in divorces where there is a significant difference in income as opposed to where the parties’ incomes are similar. Where a high income earner is paying alimony they are usually in a higher tax bracket, so the tax deductibility of the alimony can save the payor - and even the family unit as a whole - a significant amount of money. This savings is sometimes so important that parties with potential alimony payments will build all other financial aspects of the divorce around alimony, and calculate which scenario will give the best tax break or keep the most money in the family over all.
The Tax Cuts & Jobs Act of 2017– A Divorce “Penalty”?
Among other changes, under the new tax law, even though the recipient would take the alimony tax free, the total tax bill per family will go up. The payor would pay alimony with post-tax dollars and would no longer have the benefit of that alimony tax deduction. The recipient’s net income would increase, which in this case would be a benefit to the recipient, if the alimony order stayed the same. However, the payor’s detriment will result in a higher tax payment overall for the family and likely lead to lower alimony orders.
Two Classes of Divorced Couples
Under the new tax law, the change to alimony tax deductibility doesn’t take effect until January 1, 2019, and doesn’t apply to alimony agreements entered before that. This means that people divorced prior to December 31, 2018 will continue to have their alimony payments deductible to the payor and taxable to the recipient (benefiting from the tax bracket differences). Meanwhile, those divorced after December 31, 2018 will not get that benefit (unless the law changes again).
What happens when the alimony payor or recipient wants to modify the alimony order?
Generally, alimony orders are modifiable when there is a material change (though this is not the case for survived orders). The difference in taxes resulting from the new plan would certainly be considered such a change, except that the provisions don’t apply retroactively to old agreements. So this tax law won’t result in a change that causes the need to modify the order. If other changes occur and the parties are looking to modify their alimony order, the new tax law allows them to keep the tax deduction unless they opt out in their modification agreement. It’s not clear how court orders will be treated until the IRS writes regulations on this issue.
If your divorce takes place after December 31, 2018, how will this tax change affect you?
There are some important things to consider if your divorce is taking place in this new tax scheme:
First, educate yourself about the details of alimony in Massachusetts. The Alimony Reform Act contains language limiting the amount and duration of alimony, as well as defining multiple types of alimony. You can learn more about The Alimony Reform Act and subsequent case-law here: Skylarklaw.com/alimony The new tax law means that these payments will not tax deductible to a payor for post-2018 divorces, nor will the income be taxable to the recipient. This may affect how the Alimony Reform Act caps are enforced, but we won't know for sure what the court will do until there is new case law.
Second, if you intend to obtain an alimony order through agreement, pay attention to the details in the language that will be part of the order or agreement! Remember, survive means that an agreement cannot be changed by a court in the future. So if you have alimony surviving, consider carving out circumstances under which you would want flexibility to modify the order, such as if there is a change in the tax law. If the tax law changes back and alimony becomes tax deductible again, it may make sense to adjust your order. Overall, orders and separation agreements as part of divorces should be written specifically enough to be clear, while at the same time being flexible enough to allow for modifications in extreme or unpredictable circumstances such as changes in the tax law.
Finally, before you file for divorce, consider out-of-court dispute resolution before resorting to litigation. Mediation and Collaborative Law are voluntary processes that give you and your spouse control over your divorce and its terms. Mediation and Collaborative Law allow you to discuss all aspects of your divorce, go over different options, and decide what is best for you and your family. Armed with the knowledge gained from discussion, you can easily write terms that work for you and give you carve outs and flexibility when and where you want it.
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