Even when both parties agree that it’s the best decision, divorce can still be emotionally and financially devastating…
as one household becomes two, but the changes in the new tax law have the potential to add even more challenges for families.
Note: The new tax laws related to divorce will not take effect until Jan. 1, 2019.
One of the most important changes in the new tax law relating to divorce is the tax treatment of alimony. Alimony is always a contentious topic in divorce. However, since there is often a disparity in incomes between spouses, alimony can be one of the best ways to help a lower earning or dependent spouse get on with their life after the divorce.
For the past 75 years, ex-spouses who pay alimony have been able to deduct the expense from their federal income taxes and ex-spouses receiving alimony payments have had to claim the money as taxable income. While no one was excited about paying alimony, the deductibility of payments made it more palatable for paying spouses. But the new tax bill will end the deductibility of payments and that means more money will go to taxes and less will be available for the family unit. Since 98 percent of alimony recipients are women, this means that less money will be available for women and children in general. While the extra taxes may not have a huge impact on wealthy couples, the difference or $200 to $300 less in alimony payments each month can have a dramatic impact on lower income couples.
So how will the new tax bill impact the amount of money available for alimony, child support, college costs, etc? Here’s one example:
Tom and Janice are married. Tom, an engineer earns $75,000 and Janice earns $25,000 as an assistant. As a married couple, Tom and Janice would owe $8,739 in taxes with the new tax law.
However, if they divorce under the new tax law, Tom’s tax bill would be $9,800 (more than their combined amount as a married couple) and Janice’s tax bill would be $1,370 for a total of $11,170. That a $2,431 difference! So, you will now have to pay what is in essence a divorce penalty.
The takeaway for ex-spouses looking to receive alimony is that they may see a decrease in the amounts they might ordinarily have received because more money is going to taxes and there is only so much to go around. In fact, some divorce attorneys are predicting that higher earning spouses will have more leverage to argue for lower alimony since they will no longer receive a tax benefit.
On the other hand, if you will be receiving alimony, you may get to keep more of what you receive because it will not be counted as taxable income. So, the net effect can be tempered by a lower tax bill. However, there is one troubling outcome and that is since it is not counted as income, barring some type of exception, it can’t be used to invest in retirement plans like IRAs as it was under the 2017 tax law where it was treated as earned income.
So, what should you do? That is, should you rush to finalize your divorce this year or wait? Since you have until Dec. 31, 2018 before the new tax laws related to divorce take effect, instead of rushing into something and possibly making mistakes in other areas, take a moment to run the numbers to see which tax situation is better for you or if it doesn’t make a difference. Then make an informed decision.
One additional note: Ex-spouses who want to modify existing agreements — created on or before Dec. 31, 2018 — can continue to follow the current 2017 tax rules, as long as they specify that in the new agreement. Otherwise, the tax treatment could be changed to reflect the new tax laws. And, typically such a change would only make sense if the ex-spouse paying the alimony is in a lower tax bracket than the ex-spouse who receives it.