Is Alimony Tax-Deductible?
The payment of alimony has always been a bone of contention for separating and divorcing couples. For many payors, the only thing that made it slightly easier to stomach in the past was that it was tax-deductible.
That was until recently.
Since 2019, if you are seeking a divorce in New Mexico and facing the prospect of spousal support payments, you may not be aware that the federal government has eliminated lucrative tax breaks that previously applied to alimony.
While the tax implications of your separation may not be the first thing you think of, the new tax rules could potentially affect many couples who enter mediation, collaboration or other divorce settlement processes.
Elimination of the alimony payment deduction
Alimony payments are often paid by one spouse to the other post-divorce.
Such payments may be substantial, especially when there is a large discrepancy between respective incomes, the marriage has been lengthy, and/or there are health considerations or other reasons that make it difficult for the recipient to support herself or himself.
For those ordered to pay spousal support according to previous agreements, potentially substantial tax savings could be made as the alimony was counted as taxable income by the recipient and tax-deductible by the payor.
This arrangement was viewed as a type of loophole in the laws; a favorable, above-the-line tax deduction that reduced taxable income even before adjusted gross incomes were calculated. The payor didn’t need to itemize to benefit from the deduction.
According to changes in the Tax Cuts and Jobs Act (TCJA), alimony is no longer tax-deductible for couples who divorce.
The TCJA ruling applies to payments required under divorce or separation instruments that were executed after December 31st, 2018, or modified after that date.
According to the changes, recipients of alimony payments no longer have to include them as taxable income.
For the payor of alimony, the savings deducted from spousal support payments no longer apply. This makes them more expensive for many payors – especially ex-spouses in the higher tax brackets.
Changes to the alimony laws
For decades before the TCJA was passed, payments had to be clearly specified in the divorce agreement and had to be mandatory to be classed as alimony. Payments made either voluntarily or outside the terms of the divorce agreement did not count as alimony.
Also, cash payments were the only form of alimony that counted. Transfer of property or other possessions did not count as alimony.
To claim an alimony deduction, the tax return from the payor included the Social Security number of the recipient and would have to meet some other basic requirements. It was fairly straightforward for most payors of standard spousal support to claim the deduction.
Since the Tax Cuts and Jobs Act was passed, with alimony no longer available as a deduction for newly divorce couples, this all changes.
Now, a taxpayer earning $100,000 and paying $20,000 in alimony could end up paying up to almost $4,500 more in federal taxes because the alimony is not deductible. The recipient would not have to report the income or pay tax on it, of course.
Note, however, that the tax changes do not affect everyone who receives spousal support – and the tax rules regarding child support have not changed (child support has never been deductible).
Are there any exceptions and who still get the deduction?
For anyone historically paying or receiving alimony payments prior to December 31st, 2018, the law hasn’t changed.
Payors can continue to treat the payments as deductible and recipients will continue to report them as taxable income.
However, divorced couples frequently modify existing spousal support agreements. It is advisable if you are planning to do this to make sure that the law changes do not affect your tax position. The TCJA, however, anticipated future modifications of divorce settlements and allows for future modifications to still be taxable and deductible.
Consult with your divorce lawyer or tax accountant if you are considering modifying an existing agreement, to make sure that existing tax breaks are not adversely affected.
How do you approach alimony in a settlement?
The financial implications of a divorce are always one of the major considerations.
The subject of alimony is often contentious and has now been made potentially more so because of the elimination of tax breaks.
This could make alimony payments amount to thousands of dollars more every year for many payors. Whereas alimony tax laws previously favored the payor over the recipient, the new law has taken away the tax advantage.
Therefore, many mediators and arbitrators will want to propose adjustments to divorce settlements to account for the new tax regulations.
For instance, an alimony payment may need to be adjusted down from what it would have been in previous years so that the payor is not adversely affected. Alternatively, changes could be made to balance child custody and spousal support payments in light of the new laws. Other pre-tax assets such as IRA’s, real estate or other assets transferred from one party to the other in lieu of alimony might be substituted for alimony. If that is possible, the parties can avoid tax payments completely.
At the New Mexico Legal Group, we can assist you in making sense of the tax rules and how they may affect your divorce settlement.