The recent tax law, the Tax Cuts and Jobs Act, changed the federal deductibility of alimony. In divorces finalized during 2018, alimony is tax-deductible for the payor and taxable income for the recipient. On Jan. 1, 2019, however, the new tax law changes that. For divorces finalized after that date, alimony will be neither tax-deductible nor taxable income. This applies to all payments the IRS considers alimony.
This changes some of the incentives during spousal support negotiations. If you’re considering or involved in a divorce where alimony is an issue, you will receive different tax treatment if you finalize your divorce during 2018 than you will if you delay.
Moreover, the 2018 rule is more favorable to alimony payors, while the 2019 rule is more favorable to recipients. This could make it more difficult to come to a timely resolution. However, the divorced pair often saves more money overall under the 2018 rule.
How does the 2018 rule save the divorced pair more money?
Considered as a pair, the divorced couple will save money overall when the alimony payor is in a higher tax bracket than the recipient. Here’s an example:
If Spouse A pays $30,000 in alimony and is taxed at the 33-percent, the deduction saves Spouse A $9,900.
If Spouse B is taxed at the 15-percent rate, Spouse B pays $4,500 in taxes on the $30,000 alimony income.
Since Spouse A saved $9,900 and Spouse B only paid $4,500, the pair is better off by $5,400 overall.
Although Spouse A gets the immediate benefit of this, the benefit to Spouse B is that Spouse A may be able, for example, to contribute to non-mandatory child-related expenses. Spouse A may also be more likely to make the alimony payments regularly.
Under the 2019 rule, Spouse B will pay nothing to the IRS. In such a case, Spouse B may be more able to pay unexpected expenses.
What does the IRS consider alimony?
The IRS has a number of specific requirements for what it considers alimony. The payments must:
- Be pursuant to a divorce or separation agreement or decree
- Be made directly or on behalf of a spouse or ex-spouse
- Be paid in cash or its equivalent
- Include the recipient’s Social Security number
Also, the payments must not:
- Be designated “not alimony”
- Be classified as or deemed child support
- Be to a spouse or ex-spouse living in the same household or filing jointly
- Continue after the recipient’s death
The proper timing of your divorce depends on a number of factors beyond the tax treatment of alimony. You should work with your attorney to clarify your goals and time your divorce to maximize them.