It’s no fun getting divorced. But for almost 80 years the tax law helped out divorced couples. Payments of alimony or separate maintenance made by one ex-spouse to the other under a divorce or separation decree have long been deductible by the paying spouse and taxable income to the receiving spouse. Indeed, this deduction was an especially valuable “above the line” deduction from gross income that could be taken whether or not the paying spouse itemized his or her personal deductions.
The alimony deduction saved on taxes because the alimony-paying ex-spouse was usually in a higher tax bracket than the alimony-receiving ex-spouse. For example, if an alimony payer was in the 34% tax bracket, he or she would save $3,400 in federal income tax for every $10,000 in alimony payments deducted. If the recipient was in the 10% bracket, he or she would pay only $1,000 in tax on the $10,000. The total tax savings was $2,400. Divorce settlements took this tax savings into account and it often allowed for larger alimony payments.
However, starting January 1, 2019, a whole new tax regime applies to alimony. The Tax Cuts and Jobs Act (TCJA), the massive new tax law enacted by Congress in 2017, permanently eliminates the deduction for alimony payments made for people who get divorced in 2019 and later. Moreover, alimony recipients will no longer be required to pay tax on their alimony payments or include them in income. Thus, for example, an alimony payer who got divorced in 2019 or later and who pays $10,000 will get no deduction, and will have to pay tax on the amount at his or her individual tax rate—as high as 37%. The alimony recipient need not pay any tax on the $10,000. More tax ends up being paid if the payer is in a higher tax bracket than the recipient. The new regime is expected to generate $6.9 billion in additional income tax revenue over the next ten years.
These changes apply to divorces or legal separations finalized January 1, 2019 or later. The old rules continue to apply to divorces finalized before January 1, 2019—that is, alimony will remain deductible by the payer and taxed to the recipient. However, pre-2019 divorce or separation agreements can be modified to apply the new rules to future payments. The modification must specifically state that the TCJA treatment of alimony payments (not deductible by the payer and not taxable income for the recipient) applies. Such a modification is purely voluntary. There could be situations where applying the new TCJA rules voluntarily would benefit both ex-spouses—for example, where the recipient is now in a higher tax bracket than the payer-spouse.
As a result of the new rules, alimony payers will likely want to pay less alimony than they would have if they could deduct the payments.
If the alimony recipient is 59 1/2 years old or older, there is a way around this tax change: Include retirement funds in a divorce settlement. For example, the payer-spouse could transfer funds from his or her IRA to the recipient-spouse’s IRA. The transfer would not be taxable to the payer, but the recipient would have to pay tax on it at his or her individual tax rate. This would be a one-time tax on the full amount transferred, not on periodic payments from the IRA. Such a transfer of retirement funds could partially or entirely replace traditional alimony. However, this scheme does not work well if the recipient is under 59 ½ years of age because a 10% early withdrawal penalty would have to be paid on the transfer in addition to regular income tax.
Note that the rules discussed above apply only to alimony—cash payments made to an ex-spouse under a divorce or separation agreement that are paid as long as the ex-spouse is alive. Child support or most other payments made as a result of a divorce are neither tax deductible nor taxable.