The Tax Cuts and Jobs Act of 2017 and Your Divorce

• Lisa Derr
• January 25, 2018
• 0 Comment
• 1975 Views

If you are considering divorce, you may wonder how the tax act of 2017 could affect your final agreement. Congress made changes in many areas including new tax brackets, modified deductions as well as significant corporate tax changes. A lesser known change is the tax treatment of alimony paid upon divorce.

What is Alimony?

Alimony, maintenance or spousal support (however it is described in your state) represents a payment from a higher-earning spouse to the other spouse for their support after a divorce.

How has Alimony Changed?

Decades ago, higher income spouse (generally husband) paid alimony to the lower-earning spouse for longer periods. In a very long divorce where the wife had no skills, courts sometimes ordered permanent maintenance. In addition, courts have shortened the time frame considering the recipient spouse’s earning capacity through education or experience within a current job.

Changes in Comparing Spouses’ Fault

Until 1969, every state in the country considered the fault of each of the parties which affected property division and alimony payments. This could be abandonment, adultery, extreme cruelty, etc. Now, only approximately half the states take fault of the parties into consideration when determining whether to award alimony. Some states have a hybrid system where the parties may waive a waiting period if they agree to a no-fault divorce. The 2017 tax law did not impact the consideration of fault in alimony.

Alimony Deduction with the Prior Law

Under the prior law, the higher-earning spouse deducted alimony, maintenance or spousal support and the lower-earning spouse included those payments in their taxable income. By shifting the tax obligation to the person with the lower tax rate, the couple paid fewer taxes overall. Our attorneys at Derr & Villarreal have helped couples find an settlements that minimizes the total taxes paid. 

Here is an example of how it works. Bill is a investment banker who makes $320,000 and Amy is a librarian. They’ve been married for 32 years and have no children. Under the old law, if Bill paid Amy $5,000 per month in alimony, he could deduct $60,000 annually from his $320,000 annual income. He would have adjusted gross income of $260,000. His federal tax would be approximately $62,000. If he didn’t deduct it, his federal tax would have been approximately $82,000. This results in $20,000 in federal tax savings! If Amy included the alimony in her income, her tax would be $15,000. If she didn’t include the alimony, her tax would be $2,000.

If Bill saves $20,000 and Amy pays an additional $13,000, Bill and Amy together save $7,000 in federal taxes that are never paid by either of them as shown in this table:

Alimony with the Tax Deduction Eliminated

But under the new law, the government receives more money from divorcing couples because alimony will no longer be deductible for parties who signed settlement agreements after January 1, 2019. In this new scenario, Bill could pay Amy $5,000 per month but without being able to deduct it, his total federal tax remains at $82,000. (This does not take into effect other tax changes in 2018 such as the elimination of the personal exemption or doubling of the standard deduction.)

The good news is that couples with significant earnings disparity who have decided to divorce can take advantage of the fact that all agreements signed before January 1, 2019 will allow the payer to deduct payments to the recipient.