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February 20, 2018

Legal Update

How does the elimination of the alimony tax deduction affect your clients?

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With the 2017 passage of the GOP tax overhaul bill, alimony has been eliminated and divorce is about to undergo a sea of changes. Since 1942, the theory of alimony had been to allow divorcing parties to transfer income from the spouse earning a higher income to the spouse earning less income. The idea was to create more expendable or disposable income to the family by providing the higher wage earner with a tax deduction for the alimony paid and for the lower wage earner to show these payments as income. The spouse with less income would pay less tax to the IRS than the higher wage earner would pay on the same money. The income received by the lower wage earner would be taxed at a reduced rate and would decrease the overall tax liability of the family which would therefore provide more disposable cash to the family.

In many cases, alimony allowed many divorcing parties to afford to live separately in two separate households. The existence of the alimony tax deduction provided many divorced couples with significant tax savings and helped facilitate settlements that made sense financially to both parties.

The GOP tax bill, enacted at the end of 2017, has eliminated the incentive for parties to settle. Section 11051 of the tax overhaul “repeals the deduction for alimony or separate maintenance payments from the payor spouse and the corresponding inclusion of the payments in the gross income of the recipient spouse..”  This means that the higher earner will no longer be able to deduct his or her alimony payments and the recipient spouse will no longer be required to include these payments as taxable income.  The effect of this change will make it more difficult for families to live apart and provide less disposable cash to be spent on the family. In turn, this change might in many cases prolong the divorce process and require the parties to be more creative on how to transfer income from one spouse to another.

Many divorcing couples argue over the need to pay spousal support.  The elimination of the alimony deduction will likely cause more acrimony during the divorce process and fuel the fight as to whether or not a spouse is truly in need of support. Meanwhile, like many states, Massachusetts,  promulgated alimony statutes that provide for guidelines and formulas for calculating alimony based on the ability of one spouse to take the alimony tax deduction and for the other spouse to show these payments as income. States will now be pressured to review and revise these alimony guidelines to eliminate the tax affecting consequences of paying spousal support.

The elimination of the alimony deduction will start on January 1, 2019 and will not be retroactive.  That means if parties were divorced prior to January 1, 2019, and the separation agreement calls for one spouse to pay alimony, the payments would remain deductible for the payor and includable in the income of the recipient.

Couples contemplating divorce in 2018 should be aware of the elimination of the alimony tax deduction when discussing settlement.  In addition, divorcing couples should be advised that the GOP bill modifies the child tax credit by temporarily increasing it from $ 1,000 to $2,000 per qualifying child under the age of 17, and allows a $500 non- refundable credit for each dependent of the taxpayer who is not a qualifying child. This credit is phased out at AGI levels of $400,000 for married taxpayers filing jointly and $200,000 for individuals. Beginning in 2019, the increase in the child tax credit may become more valuable and should be considered in all future divorce settlements.