The Tax Cuts and Jobs Act passed in December 2017 included new alimony tax rules that apply to divorce or separation agreements executed after Dec. 31, 2018.
The changes can dramatically affect each spouse’s finances, and so are expected to increase the contentiousness of the divorce process.
Beginning on January 1, 2019, the ex-spouse that pays alimony will no longer be able to deduct this expense from their federal income tax. Because divorce settlements finalized before year-end 2018 will be grandfathered into existing rules, it may make sense for individuals contemplating divorce to agree alimony terms this year. That way, they will be able to deduct alimony payments this year and in the future.
In addition, after January 1, 2019 the ex-spouse that receives alimony will no longer owe federal tax on this income. As a result, many will want to wait until next year to finalize the terms of their divorce, in the belief that doing so will benefit them financially. But the overall net impact may hurt them financially rather than benefit them.
For individuals paying alimony, the tax deduction is very important, as it lessens the impact of the payments. The new rules that eliminate the deduction could affect payers in several ways: they will lose the deduction; without the deduction they may be pushed into a higher marginal tax bracket; and they will have fewer available dollars with which to pay the spousal support.
Alimony recipients have the opposite incentive. It might appear to be beneficial to wait until 2019, when no federal income tax will be owed on the alimony income. But the ex-spouse payor will have more reasons to lower settlement payments after 2018, and so delaying the divorce may not automatically result in a higher payment to the recipient.
Further, the size of the payment reduction might outweigh the savings from no longer owing tax on the income, since many recipients could be in a low tax bracket due to other changes in the tax laws.
If alimony is a point of contention, the payer might consider an asset transfer instead, such as a lump sum payment. This can be an attractive option, because the value of the asset transfer is not taxable to either party. Of course, this avenue is only open to those who can afford a large upfront payment.
If at all possible, divorcing couples should try to work out their finances together. But if this isn’t possible, they should seek assistance from a professional intermediary, such as a mediator, financial planner or divorce financial analyst, to avoid slowing down the divorce process.
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