Preserving Alimony Deductions After New Tax Law

Question:  My spouse and I are about to divorce.  Can I deduct any alimony payments I make to my spouse?

Answer:  The new tax law modifies the treatment of alimony payments to former spouses pursuant to divorce and separation instruments.  Alimony payments have historically been deductible by the payor spouse and taxable to the payee spouse. Effective for divorce and separation instruments entered into after December 31, 2018, alimony payments will no longer be deductible by the payor spouse nor taxable to the payee spouse.  The new law also disallows the deduction and taxability of alimony payments under divorce or separation instruments entered into on or before December 31, 2018 which are modified in certain respects after that date.

The Internal Revenue Code defines alimony, also known as maintenance, as payments made under a divorce or separation instrument provided the payment is not designated as one which is not intended to be deductible by the payor from income taxes nor includable in the payee’s taxable income. Further, spouses may not be members of the same household when the payment is made and no liability for the payment of alimony can exist after the death of the payee spouse. Payments which are fixed as child support under the divorce or separation instrument will also not qualify as taxable and deductible alimony. Various other rules apply in determining whether a payment can be treated as alimony for tax purposes.

The effect of the tax law change will largely impact a divorcing couple where there is a meaningful difference in the marginal income brackets of the payor spouse and the payee spouse.  Deductible alimony payments provide a means for the payor spouse to make a larger payment to the payee spouse.  The government is effectively subsidizing the obligation by permitting the payor spouse who presumably is in a higher income tax bracket to make payments to the payee spouse who is presumably in a lower income tax bracket.  Under the new law, once effective, the government will no longer subsidize alimony payments.

An opportunity still exists to benefit from an alimony deduction so long as your divorce or separation instrument is executed on or before December 31, 2018.  You must of course recognize that the deduction and taxation of alimony will likely only provide a meaningful tax benefit if there is a spread in the income tax brackets between you and your spouse. If you and your spouse are in the same or similar income tax brackets, the new law will likely not modify the economics of the arrangement between the two of you.   Furthermore, where no alimony will be paid, the new law will not impact a divorcing couple.

The new tax law will not modify the other rules which apply to divorcing couples. Most notably, transfers incident to a divorce continue to be nontaxable events for a divorcing couple if the statutory requirements are satisfied. Divorcing couples still have the flexibility to divide appreciated property between them without regard for income taxes. Property settlements are almost always outside the realm of alimony payments.

For those divorcing couples likely to be adversely affected by the new tax law, there will be an emphasis on entering into divorce and separation instruments in 2018.  The new law allows a window of time for divorcing couples to continue to take advantage of the pre-tax act tax changes.  Of course, before you exercise undue efforts to expedite and conclude your divorce proceedings in 2018, you should first determine if the new tax law will even impact your situation.

 

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfnr.com.