The Tax Cuts & Jobs Act Drastically Alters the Tax Consequences of Divorce
The Tax Cuts & Jobs Act (TCJA) made sweeping changes to exemptions, deductions, and credits for your family’s federal income taxes. But one major change that you might not have noticed is the way the law altered the potential tax consequences of divorce.
Unlike child support, alimony payments have long been tax-deductible for the ex-spouse making the payments and taxed as income for the recipient. And alimony payments were an above-the-line deduction, meaning that the payor did not need to itemize in order to benefit from the tax advantage. Because the spouse making payments was typically in a higher tax bracket than the recipient, shifting the income to the recipient’s lower tax bracket could result in significant overall tax savings. Indeed, this tax savings was often an important factor when negotiating divorce settlements, and it often led to larger alimony payments. However, the TCJA repealed the alimony deduction and totally reversed the tax obligation: For divorce or separation agreements executed on or after January 1st, 2019, alimony payments are no longer tax deductible for the paying spouse, and alimony is no longer considered taxable income for the recipient. Divorce or separation agreements executed before January 1, 2019 are grandfathered in under the law, meaning alimony will remain tax deductible for the paying spouse and taxed to the recipient. That said, pre-2019 divorce agreements can be modified to apply the new rules to future alimony payments, provided the modification expressly states that the TCJA new tax treatment should apply.
Indeed, there could be situations where voluntarily modifying divorce agreements put in place before 2019 to apply the new tax treatment would benefit both parties. One example might be if the recipient spouse is now in a higher tax bracket than the payer-spouse. Consult with us to determine if such modification makes sense for your particular situation.
Unlike many other new provisions of the TCJA, which will sunset in 2025, the repeal of the alimony deduction is permanent. It will remain in effect unless Congress makes future changes to the tax code. Broad implications It’s important to note that these rules don’t just stand to affect those divorced after December 31, 2018. The repeal of the alimony deduction could also impact couples who’ve been divorced for years—and even those still happily married. For example, those whose current divorce settlements were based around tax assumptions that no longer apply may want to renegotiate alimony payments to better align with the new tax code. Similarly, married couples who put prenuptial agreements in place based on the old tax rules should review those agreements to determine if the terms need to be altered in light of the new tax responsibilities.
A new playing field
By upending alimony procedures that have been in place for more than 70 years, the TCJA stands to completely reshape the divorce landscape. In turn, the law also stands to alter estate-planning and retirement strategies that were built around the previous tax advantages offered by the alimony deduction. Whether you’re in the midst of a divorce, have been divorced for years, or are married with a prenup, it’s critical that you meet with your estate planning attorney and qualified tax advisor to discuss how this provision of the TCJA stands to affect you. Depending on your situation, you may want to modify your existing legal agreements to bring them into better alignment with the new rules. Or, there may be planning tools available that could offset or lessen the new law’s impact on your tax obligations. Schedule a Family’s Future Planning Session today to learn more.
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