While the new Republican tax legislation is called the Tax Cuts and Jobs Act (TCJA) there will be no tax cuts for folks divorcing in 2018 and the message is hurry up!
What is new in the TCJA?
Before the new legislation, divorces that included alimony, income payments from one spouse to another, were tax deductible to the person paying the alimony and taxable to the recipient. Under the new legislation this deduction is eliminated and the payment to the soon to be ex spouse is no longer taxable. why hurry? Only agreements signed and approved by December 31, 2018 will retain the old tax characterization.
Why does this matter?
Suppose Harry pays Sally $5,000 per month in alimony. Sally get $5,000 in income but must declare it on her tax return because it’s treated as taxable income to her. If Sally is in a 24% tax bracket she will keep $3800. Let’s assume that Harry is in a highest 2018 tax bracket of 37%, when he pays his alimony to Sally, he gets to deduct it from his taxable income generating tax savings of $1850 so the net cost after taxes is $3150.
So Sally keeps and the $3,800 but it only costs Harry $3150? Harry’s tax savings is footing part of his alimony bill and the IRS doesn’t like it. The new legislation is intended to close this loophole.
The New Tax Law and Alimony
The new legislation affects any agreement entered not after December 31, 2018. entered into means approved by the courts, so even if signed before December 31st they are not truly affected until approved. This means most couples should check their jurisdiction to determine lead time to filing. For some, the deadline is coming soon.
Why should you care?
The tax advantages of alimony have made the income portions of a settlement discussions more palatable. Alimony is often necessary, particularly in the transition years immediately following a divorce for that spouse needing time to get on their economic feet. But it is often also the most difficult part of a negotiation.
As we saw above, alimony shifts income from a high tax bracket to a lower one. This may seem unfair to married couples, but those couples already enjoy the benefits of a lower tax bracket in the joint tax bracket. Regardless, new legislation ignores this and removes the tax advantages of alimony. After 2018 alimony a will no longer be that valuable negotiation tool used by attorneys across the country to help settle divorce cases. Couples already in the midst of divorce negotiations should take note. The economics will change dramatically after 2018.
While the date is set to be December 31, 2018, divorce takes time. Delays necessitated by your jurisdiction will have an impact. Be certain that you are aware of requirements like mandatory child impact meetings and state determined cooling off periods and factor them into your time line for filing. Consult with a tax preparer, attorney and/or divorce financial expert to help you understand how the tax law changes may affect your divorce. But if divorce is in your future tick, tock!