As most are aware, the Tax Cuts and Jobs Act passed in December 2017, will become effective on January 1, 2019. While there will be a major impact on several different facets of tax law and reform, the Act will implement a major change in family law, specifically the divorce arena. Section 11051 of the Act will repeal the ability of the payer to deduct payments from their taxes and change how the recipient's alimony is taxed.
In order to understand how the Act will affect alimony in divorce cases, it is important to know the tax implications in regards to alimony under existing law. Currently, the payer of alimony can deduct alimony payments from their taxes and the recipient is responsible for paying the taxes on the alimony as part of their income. Once the Act becomes effective, the payer will no longer be able to deduct alimony from their taxes and the recipient will no longer have to pay taxes on the alimony they receive.
In an article with CNBC, Ken Neumann, the director of the Center for Mediation and Training in New York City, used a hypothetical in an attempt to simplify the tax effects on alimony under current law compared to the new law. "A man who earns $500,000 a year and is in the top tax bracket is paying his wife $100,000 a year in alimony- but it only costs him roughly $50,000, after the tax break. The ex-wife receives the $100,000, but is left with $75,000 after taxes. Now Neumann said he could see many cases where the ex-husband will argue that he can only afford $50,000, and the ex-wife would be left with $50,000 a year - or $25,000 less." According to Neumann the recipients will be most negatively affected by the new law, although on its face it may seem the opposite, because without the tax benefit the payer will likely be paying far less than under existing law.
Many family law attorney, divorce experts, and financial specialists have discussed several ways that this new Act will negatively affect divorce cases. Under present law, the payer was entitled to some relief on their taxes, because they were able to deduct their alimony payments. This "tax relief" has acted as a sort of incentive, encouraging the parties in the divorce proceedings to agree on an alimony amount more efficiently, move the proceedings along in a more reasonable time, and avoid having to go to court.
Now, attorneys and financial specialists are concerned that the new law will lead to more divorce cases having to go to trial, instead of being settled outside of the courtroom. Additionally, because of the potential increase in court costs and the potential prolonging of the divorce process, the overall cost of getting a divorce will likely increase, resulting in couples not being able to afford a divorce and having to remain unhappily married. Finally, the recipient cannot invest alimony into their retirement account under the new law, because it will no longer be taxed as income and retirement accounts require that the money invested be taxed as income. This could result in future financial instability for the recipient's, which undermines the very purpose of alimony.
Who will be affected by the new tax law? The new law applies to any divorce or separation instrument as defined within the IRS Code of 1986 that is executed after December 31, 2018. If you are currently paying or receiving alimony, you will not be affected by this change unless a petition for modification is filed with the court that specifically states that the amendments made by this new law apply to the modification. It is imperative to point out that most alimony agreements made prior to January 1, 2019, were likely based on the payer's ability to deduct the payments from their taxes. Because of the new law, couples may be inclined to go back and modify their agreements in order to avoid overpaying alimony under the agreement that they made previously.
Although each state differs in having their own rules for alimony as far as how to determine how much alimony should be paid and when the payments should occur, alimony has always been deductible for the payer and the recipient has always paid income tax on it, regardless of the state. With the new tax law, this is no longer the case and as discussed above, there are several consequences that will negatively affect alimony and divorce law in general. If you are currently involved in divorce proceedings, ensure that you and your attorney fully understand the ramifications of the new tax law to get the best outcome. You may need to rush to get things finalized before January 1, 2019.