New Tax Law Changes for Alimony

If you are in the process of divorce right now or are considering divorce, you may have heard that the way Alimony is treated for tax purposes is changing.

THE CURRENT LAW

The way things work right now is that the person who pays alimony to an ex-spouse can deduct the full amount paid from their taxable income.  The recipient of the alimony must treat the full amount as taxable income.

Because of the way this works, the payer of the alimony is not really paying the full amount and the receiver of the alimony is not really receiving the full amount.  Let me give you an example:

John and Pam are divorced, and John is required to pay Pam $5,000 a month in alimony.  Based on their respective tax brackets (Pam is in a lower tax bracket and John is in a much higher tax bracket), the actual net amount received by Pam and paid by John is not $5,000.  Pam will net $3,750 after paying taxes on the $5,000 and John will have an out-of-pocket cost of $3,000 after taking his deduction.

This means that Uncle Sam is missing out on about $750 in tax revenue and therefore a new law has been created and structured to eliminate this.

THE NEW LAW

The new law no longer allows the payer to deduct alimony and will not be treated as taxable income to the recipient.

DECEMBER 31, 2018

 This is the magic date that the law will go into effect.  Here is the deal:

It applies to divorce cases that are finalized (not just filed) with the Court after December 31, 2018.  Cases that are finalized by December 31, 2018 will be grandfathered under the current tax law.

WHAT THIS MAY MEAN TO YOU

Right now, and for the past 75 years, the tax deduction for alimony has been used as a negotiating tool when settling divorce cases.  It is taken into account by judges that have discretion when awarding alimony and the amount of alimony they award.

It is hard to predict what will happen with alimony awards going forward but you can bet this new law will have a significant impact on which cases settle and on the dollar amount of alimony awarded.

I would caution those who are rushing to get settlements signed and accepted by the court in order to avoid the new tax law implications.  Accepting a settlement that has not been well thought out could mean you are cheating yourself out of a fair settlement that will impact your financial future.

As with any tax law change, there will be a learning curve for those who need to understand it most – tax preparers, attorneys and financial experts.  Your best bet is to consult with a Certified Divorce Financial Analyst to determine how this law will affect your individual divorce settlement and to have the confidence that the settlement you accept is financially sound.