The Tax Cuts and Jobs Act has turned the tax code upside down on alimony, especially in terms of tax deductions.
As of January 1, 2019, the tax code on alimony will change for those filing for divorce or separation. The new law eliminates alimony deductions for the payor and does not require the payee to report the alimony payments as taxable income.
Since alimony payments are made to the spouse who makes less money, the alimony payment was typically taxed at a lower rate. The tax code change repeals a 75-year-old law in an effort to tax the alimony in a higher tax bracket.
Under previous law, the payor of alimony could deduct the full payment amount from their annual earnings. The payee was then required to claim the alimony and add it to their income.
For example, if the payor earned an annual income of $150,000 and paid $40,000 in alimony, the payor could then deduct the $40,000, only paying taxes on the remaining $110,000. If the other spouse had an income of $60,000, then the payee would be required to pay taxes on the total income of $100,000.
Effective in 2019, the payor will pay taxes on the $150,000, and the payee will pay taxes on the $60,000.
Please note that if you are currently paying or receiving alimony, the changes contained in this notice will not affect you. Tax deductions on existing alimony agreements will be upheld by the IRS. Be advised, however, if you make any modifications to the alimony agreement after December 31, 2018, the new alimony rules may potentially affect your situation. You should consider seeking legal and tax advice regarding tax treatment of any modifications before signing off on the changes.
In addition to alimony changes, the tax reform bill also made revisions to child support, eliminating the personal/dependent exemptions. Effective January 1, 2018, exemptions no longer exist. As of this year moving forward, neither parent of established or future child support agreements will be able to declare any children as exemptions on their federal tax returns.
We are here to help you navigate these changes should you need tax advice on the existing or upcoming impacts of tax reform. Please contact your advisor at (805) 963-7811.