By Jacqueline Roessler, CDFA®
Getting divorced in 2018 and planning to pay or receive alimony? You may not realize it, but there’s a tax “timer” hanging over your head and the buzzer is set to go off.
Based on current tax law, the payer of alimony may deduct the full amount from their taxable income which, in turn requires the recipient to treat it as taxable income.
Suppose Harry pays Sally $5,000 per month in alimony. Sally doesn’t get to keep $5,000 because it’s treated as taxable income to her. Based on her tax bracket, her actual monthly net is $3,750. Conversely, since Harry is in a higher tax bracket than Sally, when he writes a check to Sally for $5,000, the deduction translates to an out-of-pocket cost to him of $3,000.
What about the difference between the $3,750 that Sally nets and the $3,000 that it costs Harry? Uncle Sam has been footing the bill on the $750 differential in tax revenue. That is exactly what this new regulation is structured to eliminate.
The new tax law does away with the tax deduction for alimony. Of course, alimony also won’t be treated as taxable income to the recipient. The new law goes into effect for divorce cases finalized (not filed) with the Court after December 31, 2018. Cases finalized by December 31, 2018 will be grandfathered into the old tax law.
In practical terms, taxable alimony shifts income from a high tax bracket to a lower one. Some have argued that it gives divorced couples an unfair financial advantage not available to married couples. However, for the past 75 years, the tax deduction has made alimony a valuable negotiation tool used by attorneys across the country to help settle divorce cases. In fact, it’s often one of the only ways to provide a guaranteed win/win during a difficult financial time for both parties.
Although divorce attorneys and their clients may think they have until year-end before they need to worry about the changes, many states have a mandatory cooling off period once the case has been filed with the Court. Michigan, for example has a 60 day waiting period, however, for couples with minor children, the waiting period is typically extended to 180 days. Therefore, depending on where you live and if you have minor children, you may only have until the end of June 2018 to file and take advantage of tax deductible alimony.
As always, every case is different. Consult with a tax preparer, attorney and/or divorce financial expert to help you understand how the tax law changes may affect your divorce.