If you have been thinking of getting divorced, the Republicans in Congress may have given you a reason to add divorce to your 2018 resolution list. Why? The new tax code eliminates the 75-year old alimony deduction. Without the deduction, negotiating a divorce settlement may become a lot more difficult and expensive. If you think you would be a payor or recipient of alimony, now is the time to speak to a divorce lawyer.
The new tax law eliminates the alimony deduction beginning on January 1, 2019. Prior to the recent overhaul of the tax code, the payor of alimony (known as Spousal Maintenance in New York) could deduct those payments on his or her tax returns. The recipient of alimony was required to pay income taxes on those payments. Once the alimony deduction is eliminated, the payor spouse will not be able to deduct alimony payments and the recipient spouse will receive the payments tax-free.
WHY WILL THIS MAKE NEGOTIATING A DIVORCE SETTLEMENT MORE DIFFICULT?
First, the alimony deduction was a useful negotiating tool. For the payor spouse, the deduction often helped to take the sting out of the fact that he or she would be making monthly alimony payments to an ex-husband or ex-wife. Settlements, especially those involving child support (which was never tax deductible) and alimony, were often negotiated with the tax savings from the alimony deduction in mind. For example, a paying spouse might agree to pay more support overall if some non-deductible child support dollars were shifted to tax deductible alimony dollars. When both parties could benefit (the paying spouse benefiting from the tax break and the recipient spouse benefiting from more support), settlement was easier to achieve.
Second, eliminating the alimony deduction means there will be less money available to support two households. Why? Typically, the spouse receiving alimony is in a lower tax bracket than the spouse paying. If the spouse in the lower bracket is taxed, he or she will pay less in taxes on the same amount than if the spouse in the higher bracket was taxed. This preserves more money for the family.
For example, say the payor spouse, taxed at a 30% rate, is required to pay $30,000 per year in alimony. With the deduction, paying $30,000 only costs her $21,000. This is a savings of $9,000. The recipient spouse, taxed at a 15% rate, pays $4,500 in taxes, receiving $25,500. That tax deduction meant that there was $4,500 more available for the recipient spouse that was not coming from the paying spouse’s pocket. This was “found money” and with the elimination of the alimony deduction, it is lost. The payor spouse in this situation must have $4,500 in her pocket to achieve the same result.
Less money to go around means that parties, especially the paying spouse, may feel backed up against a financial wall. Negotiating settlement packages when money is tight can prove to be more challenging than when there is enough money for everyone.
I’M THINKING OF SEPARATING. CAN I STILL TAKE ADVANTAGE OF THE DEDUCTION?
If you are considering divorce or separation, now is the time to act. If you are divorced or sign a separation agreement on or before December 31, 2018, you still will be able to qualify for the alimony deduction. Settlement negotiations take time and it is not uncommon for the divorce process to take a year or more. If you are thinking of divorce, you should speak to a divorce attorney and accountant now about how these changes will impact your situation. Greenblatt Law can help you decide how to proceed.