In the last 75 years, the rules governing alimony tax went as follows: the payer could deduct alimony payments and the recipient was required to pay income tax on the alimony received. The rather straightforward legislation worked to simplify divorce. The divorcee that paid alimony could rest a bit easier knowing they would see a reward in their tax deductions and the benefiter was not without their own responsibility.
This law helped divorce mediators maintain a healthy relationship between divorcees and further justify the alimony process. However, towards the end of 2017, the Tax Cuts and Jobs Act executed by congress changed the rules of alimony tax. This change becomes effective on January 1st, 2019 and will make the divorce process evermore difficult. It may in fact deter couples from legally divorcing completely.
Alimony Tax Deduction
As stated previously, current alimony tax laws allow the payer to deduct alimony payments and forces income tax onto the recipient. The alimony new tax bill rids of this practice entirely. Any and all divorces which take place after December 31st, 2018 with an integrated alimony plan will neither deduct it, nor will it count as taxable income.
This is bad news for the payer, especially if they are heavy-earners, as the alimony tax changes remove their tax deduction and do nothing to rectify the circumstance of the recipient. For years, these laws were treated as guidelines for the divorce process and now lawyers are reeling from panic as they try to continue mediating divorce. This law renders alimony income tax and tax deduction obsolete and will complicate the divorce process.
Do You Pay Taxes on Alimony?
For alimony payments made prior to 2019, and those who divorced during this time, alimony tax is going to work as it did previously. This means the payer must fall beneath a series of specific requirements and, if met, the alimony payments can be claimed as above-the-line deductions on the payer’s income tax return. This is then treated as taxable income by the recipient, which they will have to pay ongoing.
If the requirements for said alimony are not met, the payments are treated in the same regard as child support, rendering them nondeductible for the payer and tax-free for the recipient. Now, more than ever, there are things you should know about your spouse and their financial situation.
Requirements for Deductible Alimony
There are essentially seven requirements that deem alimony deductible and, if not all are met, can result in nontaxable and nondeductible payments. The alimony tax deduction requirements go as follows:
Payments Must be Made in Cash or Check
Alimony payments must be made by cash or check going to the benefit of the former spouse. You cannot pass off newly bought assets and clear them as alimony. For example, you cannot give your spouse an apartment and claim it as a taxable alimony payment.
Follow the Proper Documents
The payer must make the payments in accordance to what is considered a divorce document (marital settlement agreement, court order, divorce judgement, separation agreement). They must ensure the documents provide a set value for the amount paid and identify said payment as alimony or spousal support. These documents should also work to clarify that the payments are deductible by the payer and taxable to the recipient.
No Child Support, no Property Settlement
Child support payments and property settlement payments are not tax deductible. A hard divide must be created between money supporting the children and alimony supporting the ex-spouse. If the payments are in any way tied to either the children or property settlement, then they will not be deductible. Furthermore, if a link is found years after previous payments, the payer may be required to compensate for the taxes deducted. This, you could imagine, can be quite costly.
Payments Must End at Recipient’s Death
If a payer claims the alimony payments end when a child is legally considered an adult, this can raise an alarm for the IRS. The payer must ensure the payments end once the recipient is deceased. This leaves no question whether the alimony supported the ex-spouse specifically.
Divorcees Must Live Apart
If the divorcees are still living in the same property, alimony payments are not tax deductible.
Joint Tax Returns
If a joint tax return is filed, alimony payments are not tax deductible.
No Extras Up Front
A payor cannot pay the extra alimony owed up front. It must be paid incrementally, as stated on the divorce document(s).
Are Deductions Itemized?
Alimony tax deductions do not need to be itemized on the income tax return. The deductions are claimed via IRS Form 1040, which is the standard income tax return document. The payer will need to insert their ex-spouse’s social security number. Reporting alimony is generally a simple process.
Post-2018, What This Means
The new alimony tax laws will create a paradigm shift in the divorce process itself. In some ways, it already has. Today, an accountant might speak to a spouse currently in the throes of the divorce process and encourage them via tax preparation services, if they are to assume the role of the payer, to do everything in their power to file the divorce before 2019.
On the other hand, opposing advice will be given to the recipient, as they will be encouraged to withhold the divorce finalization until after 2019, in so that they receive nontaxable income. By default, this could further the tension between spouses and cause more complications.
With that being said, it may snowball and cause an effect on how alimony is overtly handled. Consider the high-income payer and his responsibility to pay alimony, as stated in the divorce document(s), who might exercise generosity knowing they will receive a massive deduction on their tax return. Now, delete that deduction and you could imagine this generosity might just jump ship.
Along with the divorce process, the new tax laws might cause ex-spouses, who already have agreements in place, to revisit them. Consider a prenuptial agreement, solidified in the past, that was tailored specifically to how the longstanding tax laws operated. Now, this could be grounds for modification, as a recipient may try to squeeze out more money by avoiding income tax.
Lastly, these new laws could change the course of a couple’s divorce entirely, forcing them to reconsider—a decision driven solely by financial circumstances. If you are someone currently looking for help with taxes, being that these very changes are at our doorstep, do not hesitate to reach out.