With divorce, like marriage, comes major financial change, and it can be taxing. The new Tax Cut and Jobs Act (TCJA) will soon make alimony payments, also called maintenance, more expensive for many members of the roughly one million couples that get divorced in the United States annually. Due to this increased expense, divorce attorneys are sure to see a spike in clients seeking to finalize a divorce or separation agreement before the new alimony provision takes effect for payments required under agreements reached after December 31, 2018.
The Coming Change
Since 1942, an ex-spouse paying alimony was able to deduct those payments from his or her income, while the recipient of the alimony was required to include those payments as part of their ordinary income and pay the tax due on the amount received. This deduction tended to preserve more money overall to allocate between divorcing spouses — helping them to afford living separately. It also encouraged the higher-earning spouse to agree to help support the spouse with a lesser income.
Example Under Current Law
A higher-earning ex-spouse required to pay $25,000 per year in alimony and whose income is federally taxed at 33% receives an above-the-line deduction against the payment amount, effectively avoiding an $8,250 income tax liability. Conversely, the lower-earning ex-spouse receives the $25,000 per year in alimony and reports the payment as part of his or her income. If the lower-earning ex-spouse’s income is federally taxed at 15%, the income tax due on the alimony payment is $3,750. Under current law, the ex-spouses save $4,500 between them and payor ex-spouse receives a deduction to make the payment more affordable.
Under TCJA, the tax burden on alimony payments has been shifted from the payee ex-spouse to the payor ex-spouse. The payor ex-spouse will no longer be able to deduct alimony payments from his or her ordinary income, while the payee ex-spouse will no longer have to report such payments as ordinary income. This could mean the payor’s cost of paying alimony will be substantially higher, thus giving the higher-earning spouse more leverage to argue for lower alimony.
Example Under New Law
A higher-earning ex-spouse required to pay $25,000 per year in alimony and whose income is federally taxed at 33%, will no longer receive an above-the-line deduction and be required to include the alimony payment as part of his or her income and pay the tax due on that amount (here, $8,250). Conversely, the lower-earning ex-spouse will no longer be required to report the payment as part of his or her income and will not directly pay any tax on that amount. Under TCJA, the ex-spouses will lose the savings of $4,500 that the current law provides.
Fortunately, those who finalize their divorce in 2018 will still be able to benefit from the alimony deduction for the entire time alimony is required to be paid. Divorce attorneys dealing with settlements beyond 2018 will need to adjust for the new tax law’s implications. Those attorneys representing the higher-earning spouse will try to lessen their clients’ required payments to reflect that they are no longer tax deductible, while those representing the lower-earning spouse will now have reduced bargaining power to achieve financial stability for their clients after a divorce.
New York Fights Back
In response to the change of the taxation of alimony payments at the federal level under TCJA, New York State, through the passing of its 2018-2019 Budget Bill on March 31, 2018, decoupled from the federal alimony provisions and added N.Y. Tax Law Section 612 (w) and N.Y.C. Admin. Code Section 11-1712(u). Both provisions allow a subtraction modification to an individual’s federal adjusted gross income (AGI) of any amounts paid as alimony and require an addition modification to an individual’s federal AGI for any amounts received as alimony during the tax year. These new provisions keep in place the current taxation of alimony payments for New York State and New York City tax purposes.
Questions? Contact Gregory Cayne at 212.324.3360 | firstname.lastname@example.org or reach out to your Berdon tax advisor.
Berdon LLP New York Accountants