- Tax law changes going into effect after 2018 will likely reduce the amount of alimony you receive (if you’re the recipient), or cost you more in alimony (if you’re the payor).
- Because of crowded court schedules, you need to begin addressing alimony now to have your case heard in time to take advantage of the current tax laws.
- You can address an alimony claim now—and receive the current, better tax treatment—even if other issues (child support, child custody, equitable distribution) aren’t decided until later.
BUT, you must act now in order to get your matter resolved before the end of 2018!
Changes To Alimony In Recent Tax Law Require Immediate Action For Family Law Cases!
As mentioned in one of our prior blogs, the recently enacted Tax Reform and Jobs Act of 2017 has drastically changed the tax treatment of alimony claims in family law and divorce cases. Alimony orders, separation agreements, or divorces finalized after December 31, 2018 will no longer receive the same alimony tax treatment. Couples contemplating separation, alimony, or divorce now have very little time to complete the process and take advantage of the current tax rules.
The new tax law will change the current tax treatment of alimony claims
Under the new tax law, if a court enters an alimony order or the parties enter into a separation agreement ON OR BEFORE December 31, 2018 the spouse paying alimony can claim an income tax deduction for the alimony payments, and the spouse receiving the alimony must take the amounts into income. Alternatively, if the Court enters an alimony order or the parties enter into a separation agreement AFTER December 31, 2018, the spouse paying alimony CANNOT claim an income tax deduction, and the spouse receiving the alimony does not have to take the amounts into income.
Alimony, as well as temporary alimony (called “post-separation support” or “PSS” in North Carolina) can be settled or adjudicated NOW. The actual divorce is the last, official act in the process. Everything else—alimony, child custody, child support, or equitable distribution—typically occurs before the actual, official divorce. Therefore, with these looming tax changes, if you are contemplating separation or divorce, it is extremely important that the process get underway as soon as possible. Even if the parties can reach a settlement on alimony claims, it can take some time to finalize the agreement. If settlement is not possible, the parties need a court ruling on or before December 31, 2018. To obtain a ruling means getting on the court’s hearing schedule—which can take several months—and then waiting for the judge to rule and enter the order. You need to get settlement talks going TODAY on at least the alimony issue if you want to receive the current tax treatment for alimony.
An example of how the old and new tax rules work
Under the current rules, the higher-paid (and therefore higher-taxed) wage earner transfers income to a lower-paid (and therefore lower-taxed) spouse. The deduction substantially reduces the cost of alimony payments for the higher-paid spouse: for people in the highest income-tax bracket, it means every dollar they pay to support a former spouse really costs them 60 cents (assuming an effective 40 percent tax rate). Paying tax on alimony is not considered expensive for the recipient spouse because of his/her lower tax rate.
As an example, if a higher-earner paid $10,000 in alimony to a spouse, the earner would deduct the entire $10,000 from income taxes. At an assumed tax rate of 40 percent (state and federal), that would cost the payor $6,000 in after-tax money. The recipient spouse would take the $10,000 into income. At an assumed tax rate of 25 percent (state and federal), the spouse would end up with $7,500 in after-tax dollars. So, it would only cost the payor spouse $6,000 to transfer $7,500 in alimony to the spouse. Financially, this is a good deal for both spouses.
Under the new tax laws, the payor spouse would not be able to deduct the $10,000 in alimony. Therefore, if the payor spouse paid $10,000 in alimony, it would cost $10,000 after tax (versus the $6,000 after tax it would cost under current rules). Therefore, it’s likely the payor spouse would only be willing to negotiate for $6,000 in alimony (to keep the same after-tax effect). The recipient spouse would not pay tax on the $6,000 in alimony received. However, as contrasted with the prior example, the recipient spouse now has only $6,000 in after-tax alimony funds, whereas in the prior example (under current tax law), the recipient spouse has $7,500 in after-tax alimony funds. So, although the recipient spouse doesn’t have to pay tax on the alimony for orders entered after December 31, 2018, the economic effect on the recipient spouse may be worse. This may hurt both parties, because there is $1500 less available than under current law. The parties, or a court, will have to allocate this loss between them in some manner.
Individuals must take special care in modifying existing alimony agreements
Alimony recipients may wonder if they should attempt to modify their existing agreements to reflect the Tax Act changes, so they don’t have to pay taxes on alimony anymore. The language of the Tax Act appears to provide that any modifications after December 31, 2018 can apply the new rules, if the modification so provides. In short, whether the new rules will apply to modifications of existing alimony agreements appears to be a further issue for negotiation by the parties. The new, generally lower individual tax rates provided in the Tax Act will mean that couples will need to consider their individual situations in 2018 to decide what to do.
Marcellino & Tyson’s family law attorneys can help
At Marcellino & Tyson, we are equipped and ready to work through these issues with you. Jennifer Moore, a Marcellino & Tyson attorney, Board-certified specialist in family law, and one of Business North Carolina magazine’s Legal Elite for family law, noted:
Our family law team is experienced in analyzing all issues related to divorce, and especially related to spousal support, to ensure our client’s rights and needs are protected. We understand the intricacies of establishing a spousal support obligation, including the effect the new tax laws will have on this obligation.
Matt Marcellino, a 2018 Super Lawyer and one of Business North Carolina magazine’s Legal Elite for family law, also observed:
We’re probably one of the few firms concentrating in family law that is fortunate enough to have attorneys with an MBA and a Masters of Law in Taxation to help us work through these types of tax and related financial issues for our clients.
If you are contemplating separation or divorce, or have a current alimony award, this legislation could adversely impact you. It is important to consult with an experienced and qualified family law attorney immediately.
The purpose of Marcellino & Tyson’s blog and information postings is to provide news, general information and a general understanding of the law. All content is for informational purposes only and is not legal advice. In addition, reading our informational news does not establish an attorney-client relationship. If you are seeking legal advice, we encourage you to contact an attorney to evaluate your needs.