2019 Tax Reforms and its Impact on Alimony
For more than 70 years, the federal tax rules regarding spousal support and taxes have been settled in this way: the supported party treats the amount she receives as earned income, on which she pays income tax. The supporting party, on the other hand, can claim the full amount of spousal support paid as a deduction.
New tax laws are now in place, effective since January 1, 2019, and it has far-reaching effects on the taxes on spousal support. Under the Tax Cuts and Jobs Act (TCJA), the tax benefits and responsibilities of the parties have been turned upside down.
Under the new tax laws, the supporting party, or the person paying support, can no longer claim the amount of support as a deduction. Instead, he or she is the one responsible for paying taxes on the amount of support. In turn, the supported party no longer has to pay tax on the support he or she receives. For the supporting party, the law provides a graduated rate of income tax depending on which tax bracket you fall into.
The old tax rules provided some benefits to the couple because the tax rate for the supported spouse who was declaring the support as income was lower. It was an incentive that allowed them to negotiate higher support payments. This is no longer true under the new rules precisely because the burden on the supporting party is heavier.
Understanding the timeline
Since the TCJA was made effective on January 1, 2019, it does not apply retroactively to divorce settlements and orders of support that were finalized on or before December 31, 2018.
If such a settlement order was finalized on or before December 31, 2018, but was modified after January 1, 2019, the question of whether or not the TCJA applies to the modified settlement agreement depends on the language of the modification.
If the parties want the TCJA to apply, there must be an express provision to that effect. The reverse is also true: the parties can expressly state in the written settlement that they are electing to treat the support as a deduction for the supporting spouse and as taxable income for the spouse receiving support.
There is no such wiggle room for settlement orders that are finalized after January 1, 2019, however – except maybe in California, which has elected not to conform to the federal alimony changes under the TCJA.
Federal Tax Changes on Alimony not followed in California
The State of California has elected to continue to allow supporting spouses to claim the support as a deduction and for the supported party to report the support payments as taxable income. Obviously, this complicates things somewhat.
However, in order for a paying spouse to claim the amount of alimony as a deduction, the following requirements have to be met:
- The payment was made in cash;
- Both parties are not members of the same household;
- There is no obligation to continue making payments after the death of your former spouse;
- The payment is not treated as either child support or as a property settlement; and
- The parties did not file a joint return
Essentially, there are now different reporting requirements for your federal and state returns if you live in California. It is highly recommended that you consult with your divorce lawyer to determine how to report alimony payments in both your federal and state tax returns if you are a California resident and are paying or receiving alimony.
Another interesting development in the TCJA is the SALT Cap, or the state and local income taxes deduction limit, which is now capped at $10,000.
This means that higher earners have a higher tax burden because of the limit of the deductions that they can claim. Practically speaking, this can make things more difficult for married couples who may want to reconsider even getting a divorce in the first place depending on their finances.
Overall, it may take some time before the effects of the new tax law can be reasonably understood in its actual impact on divorce and spousal support agreements. Please consult with a tax lawyer to better understand and determine your tax obligations.