With the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), the deductibility of alimony or spousal support on Federal Taxes is set to sunset on December 31 this year. If you are planning to divorce or in the process of a divorce that will not complete before the end of 2018, this could cost you a lot of money.
Under the previous law, spousal support (alimony) is deductible from income for the support payor and taxable to the support recipient. This was a way for parties to save money on Uncle Sam’s dime. Typically, the support payor would be taxed at a higher rate than the support recipient because of the disparity of income. By transferring the tax burden from the support payor to the support recipient, the support payor had higher net spendable income and could afford to pay more. This usually ended up in a win-win circumstance for the parties
Commencing on January 1, 2019, spousal support paid under new orders will not be deductible to the support payor and will not be taxable to the support recipient. This rule will apply to alimony payments required by “divorce or separation instruments” executed after December 31, 2018.
A “divorce or separation instrument” as defined by 26 U.S. Code § 71(b)(2) “means –
(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,
(B) a written separation agreement, or
(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.”
However, a divorce or separation instruments in place before January 1, 2019, but modified after this date, will continue to be under the current rules allowing for deductibility. They would only be subject to the TCJA, if the modification expressly provides for the TCJA to apply.
So what does this mean for people in the midst of a divorce today? To preserve the possibility of deductibility of alimony payment, they need to have a divorce instrument entered by a court before the end of the year.
It is crucial that the judgment is entered in 2018.
Although it is unclear exactly how the IRS will interpret this rule, we believe it is crucial that the divorce instrument is entered before the end of the year to preserve deductibility forever (or at least until the rule is changed again).
A huge concern is that the courts are very much behind in the processing of judgments of divorce or legal separation. Time is therefore of the essence. If a couple does not have a completed judgment to submit prior to the middle of November 2018, there is a very strong likelihood that it will not be accepted by the court in time. Thus, the parties would lose the benefit of deductibility because there divorce or separation instrument would not be entered before 2019.
Here is a real-world example from a recent higher dollar case:
In negotiations, husband and wife had agreed that spousal support would be set at $12,000 a month. Because the husband will be in the combined 46.3% tax bracket post-divorce, the after-tax cost to him will be $6,444. However, because the wife will be in the combined 34.3% bracket she will net $7,884 after tax. When the new law is in force and husband can no longer deduct his payment it would cost him $1440 more to get her the same amount of spendable money. The differential will be even greater if the wife goes ahead with her plan to buy a condo next year and thus receive the deductions for mortgage interest and property taxes.
Of course, the reality of divorce is that there is rarely enough money to go around and the result of this change is going to be that payors will end up paying more and payees will end up receiving less.
An additional impact of this change that we believe is not well understood is that because in California the software that calculates child support uses after-tax income as the input number used for income available for support, child support numbers will also be reduced.
How we can help.
To help parties maximize what they have to spend for themselves and their kids after divorce, Weber Dispute Resolution is teaming up with Pacific Divorce Management to offer an expedited to process.
Pacific Divorce Management, one of the premier advising firms in San Diego for financial issues in divorce, will work with parties to gather financial data to complete the State mandated Declaration of Disclosure Forms.
Weber Dispute Resolution, a leader in divorce mediation and legal dispute resolution, will prepare the necessary forms to open a divorce case and will work for the hand in glove with Pacific Divorce Management to prepare the necessary divorce or separation instrument necessary to satisfy the IRS requirements for deductibility.
If it is impossible to conclude the entire divorce prior to 2019, the parties could enter into a partial stipulated Judgment for spousal support that would meet the requirements for deductibility. The couple would then have the following options:
- Work with Pacific Divorce Management and Weber Dispute Resolution in an out-of-court alternative dispute resolution setting to complete their divorce or legal separation (for example, mediation or collaborative practice).
- Work with other professionals in an out-of-court alternative dispute resolution setting to complete their case.
- Litigate their divorce or legal separation from other professionals.
Whether you choose to complete your divorce with us or choose to go another way, we are pleased to offer a way for parties to take advantage of the tax laws for deductibility of spousal support payments before it goes away forever.