New Year, New Alimony Tax Rules

Starting in 2019, alimony payments will no longer be deductible by the payor or included in the recipient's taxable income.

The Tax Cuts and Jobs Act is the first significant tax reform effort by Congress in more than 30 years, and it repeals the deduction for alimony (known in Arizona as “spousal maintenance”) and separate maintenance payments, starting in 2019. Tax professionals should learn about the new changes and account for them during 2018.

Present Alimony Tax Law

Until at least January 1, 2019, alimony payments are deductible by the payor and included in income by the recipient. To be deductible, alimony payments must:

• be made in cash;
  
• be required by a divorce decree or separation agreement;
  
• cease upon the death of the recipient; and
  
• be made while spouses are living apart.
  

Also, alimony payments cannot be related to a child (i.e., disguised child support).

During my time as a senior trial attorney at the IRS, there were a significant number of cases in which the IRS disputed that these elements were met. Do not lose sight of these requirements if you are advising your clients on the deductibility of alimony payments under the present law.

New Alimony Tax Law

The Tax Cuts and Jobs Act completely upends the alimony rules by eliminating the deduction by the payor, and providing an income exclusion to the recipient of the alimony payments. This means that the total amounts considered taxable will remain the same, but the bearer of the tax liability will change.

Since payors of alimony are usually in higher income tax brackets than recipients, the shift in the party responsible for the tax means that it will generate additional revenue for the government when compared with the present law. The taxpayer in the higher income tax bracket will be reporting the income that they were previously offsetting with an alimony deduction. Almost 600,000 alimony payors rely on the alimony deduction, and the change is expected to raise about $8 billion for the government over a ten-year period.

When Do the Alimony Tax Law Changes Take Place?

As the changes do not take place until January 1, 2019, that makes for a unique opportunity for your clients to decide whether they prefer the present law or the new law, and whether the change in law should be reflected in alimony amounts that your clients agree upon with their former spouses.

A taxpayer may continue to deduct qualified alimony and separate maintenance payments made, or exclude such payments received from gross income, after 2018 if his or her divorce or separation instrument: (1) is executed before December 31, 2018, or (2) is executed before December 31, 2018, and modified after 2018 so long as it does not expressly provide that the that the repeal of the qualified alimony and separate maintenance rules of the Internal Revenue Code apply.

The special rules applicable to alimony trusts will continue to apply after 2018 under the same conditions as the deduction and the exclusion.

Practical Tips

To alimony payors in the highest income tax bracket, the alimony deduction is worth 37% of the alimony paid (2018 income tax rates range from 10% to 37%).

Alimony payors prefer to:

• finalize divorce instruments before December 31, 2018, and
  
• prevent the repeal rules from applying to any modifications made after December 31, 2018.
  

Alimony recipients prefer to:

• finalize divorce instruments after December 31, 2018, and
  
• apply the repeal rules to any modifications.
  

Following is sample draft language to apply the new law to divorce instruments originally executed before December 31, 2018, but modified after that date:

“This modification expressly provides that the amendments made by Section 11051 of the Tax Cuts and Jobs Act shall apply to the modification such that the alimony payments shall not be deductible by the payor, and shall be excluded from income by the recipient.”

Innocent Spouse Provisions

The innocent spouse provisions remain unchanged by the Tax Cuts and Jobs Act and continue to be an important tool to assist divorcing spouses with tax liabilities.