Alimony and the New Tax Plan

As everyone knows President Trump has signed into law the new tax bill. This tax bill has been a frequent subject of congress, the media, and various advocates. The change that most affects many Ayo and Iken clients is the new tax treatment for alimony payments. The change promises to effect future alimony negotiations, future court cases, and decisions whether to reopen past alimony judgments. This is a decision of national significance and will affect alimony in every single state.

You are probably aware the new tax law eliminates a key tax provision that affects alimony and its impact:

• Payments of alimony shall no longer be deductible
• Receipt of alimony payments shall no longer be considered taxable income
• In other words alimony will now receive similar tax treatment as child support.

This change represents a huge shift in the treatment and calculation of alimony. It will be years before “equilibrium” is restored in the way we negotiate, litigate, and calculate alimony. As with all new cases there will be arguments over interpretation for certain situations.

It is important to understand the current treatment of alimony payments.

Under the current tax system:

• The payer of alimony may deduct all payments of alimony.
• The receiver of alimony must claim alimony payments as income

Right now the federal government provides an invisible subsidy to alimony judgments. In other words the impact of alimony on certain sides of a situation is mildly softened by the current tax code. The effect of current law is to lessen the cost of alimony for the payer and to increase the cost of receiving alimony to the other person. But the current system does provide some advantages to both sides. Here is a quick hypothetical situation that will demonstrate how the current law benefits parties to an alimony case. We have provided some basic examples based on fictional information in an alimony case. The numbers are simple, approximate, and only provided as a rough example. The resulting tax calculations are approximate and do not take into account dependency exemptions or other various factors. Here is how the current alimony taxation system works:

Payer of alimony:

The person that pays alimony is typically a higher income earner in a higher tax bracket.  Lets say the income of the alimony payer is $100,000 / year. The net annual tax paid would be approximately $19,000 / year.

Receiver of alimony:

The person that receives alimony is typically a lower-income earner in a lower tax bracket. Lets say the income of the person receiving alimony is $30,000 / year. The net tax paid would be approximately $3,000 / year

Now let’s suppose the alimony agreement or judgment comes out to $1,000 / month, or $12,000 / year and see what happens to both sides.

Under the current tax rules:

Payer of alimony:

This person’s annual net taxable income is $100,000 less $12,000 in alimony payments for a total annual income of $88,000. That lowers the net taxes to approximate $16,000 annually instead of the $19,000 annually due before there was alimony.

Receiver of alimony:

This person’s annual net taxable income is $30,000 plus $12,000 in alimony payments for a total annual income of $42,000. That raises this person’s net taxes to $4,800 annually instead of the $3,000 annually due before there was alimony.

Notice each person’s tax decrease, or tax increase does not match. With alimony payments under the current system:

• The payer’s taxes are lowered by approximately $3,000
• The receiver’s taxes are raised by approximately $1,800

Money that did not exist prior to the start of alimony payments has now been created through a twist in the tax code. The payer ends up saving $1,200 more than the receiver when looking at their final tax obligation. This money can be kept by one party or another – or shared between the parties. The parties frequently divide the savings realized by the old tax treatment. This creates more money for both while making settlement options more appealing.

The new tax law and alimony

The new tax bill simplifies treatment of alimony and eliminates much of the complication but also eliminates potential advantages for both parties. As stated above:

• Payments of alimony shall no longer be deductible
• Receipt of alimony payments shall no longer be considered taxable income

Planning for alimony cases in 2018 and beyond

There is something very interesting in the final provisions of the tax reform bill that you should know and potentially use to your advantage. This planning tool is available throughout 2018 and may affect decisions beyond that year.

The final text of the tax bill describes the effective date for alimony treatment as follows:

(c) Effective Date.—The amendments made by this section shall apply to—

(1) any divorce or separation instrument (as defined in section 71(b)(2) of the Internal Revenue Code of 1986 as in effect before the date of the enactment of this Act) executed after December 31, 2018, and

(2) any divorce or separation instrument (as so defined) executed on or before such date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification.

There are several interesting issues to note for anyone working with an alimony situation:

• The effective date of the new tax law with regard to alimony is December 31^st, 2018.
• You have until December 31, 2018 to finalize divorce cases to retain the old tax treatment of alimony
• You have until December 31, 2018 to create a binding separation instrument – see definition below. There is no doubt the application of the tax code definition to Florida law will be litigated.  Since Florida has no statutory definition of a separation instrument the cases will revolve around prenuptial agreements, postnuptial agreements, and similar types of legal creations.

For modifications of older decrees and agreements the new tax bill suggests that a change of tax treatment can only be elected by agreement between the parties. The application and effect of this provision will probably be defined in the next few years of Florida appellate cases.

Or you may decide it is in your specific interest to establish alimony under the new tax framework.

Here is the US Tax Code Definition of Separation Instrument:

(2) Divorce or separation instrument – The term “divorce or separation instrument” means—

(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,

(B) a written separation agreement, or

(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.

The Combination of Alimony, Child Support, and Expense Payments

Many agreed settlements contain a variable compromise between child support, alimony, and payment of expenses to optimize tax benefits for both spouses. The elimination of tax implications for alimony will radically shift future settlements. The exact effect remains to be discovered.

Lower End Cases

Many agreements and judgments, tending to be on the lower end of the scale contain misinformed considerations that do not optimize taxes. People in these situations will be disproportionately harmed or benefited under the new change. Because of the latest changes it is essential that you consider all sides of your particular situation and work with your attorney to decide the best strategy.

Opportunities for 2018 under the New Alimony Tax Treatment

It is very important that you do some thinking on the potential benefit or harm should you finalize your situation in 2018 versus after the effective date of the tax change – December 31^st, 2018. Many types of cases can be delayed substantially in an effort to bring the situation under the new tax rules. Similarly it is possible to accelerate certain cases in an attempt to retain the current tax treatment.

Who Does the New Tax Law Benefit or Hurt?

All new financial laws eventually reach a point of equilibrium where the net effect is not much different than before the legislation. We suspect this will be the case with the new tax law and alimony. As a cautionary note – the writer of this article must only consider Florida alimony cases in combination with the federal tax law. But the effect will most likely be similar in many states.

In the short term the well-informed will always protect their rights and possibly come out ahead. In the long term it will be important to carefully calculate all potential payments and make decisions based on the new net payments – which will be different under the new tax code.