You may have heard that child support payments are no longer deductible for federal income tax purposes. But you may still be able to deduct it from your state income taxes. Here’s what you need to know if you’re newly divorced and filing taxes.
You may have heard that alimony payments made under newly entered divorce settlements are no longer deductible for federal income tax purposes. This long-standing deduction, which has been in place for some 75 years, was abolished by one of the most controversial and publicized provisions of the Tax Cuts and Jobs Act 2017.
With so much attention focused on losing the federal deduction, there is a related consideration that has received very little attention: Child support payments that are no longer federally deductible may still be deductible for state income tax purposes. This can be a very important point for couples seeking a divorce, especially in high-tax jurisdictions where the state tax deduction has greater value.
Federal support deduction used to be the most important consideration
The federal alimony deduction has long been an integral part of divorce planning. The old rule allowed the alimony payer to deduct his payments while the recipient paid income tax on any alimony received. The result gave separating couples the opportunity to shift taxable income from the higher-income spouse to the lower-income spouse. In cases where the alimony payments were significant, this tax treatment provided the two individuals with a valuable opportunity to save their entire federal income tax bills.
The deduction also took some of the sting out of the ex-spouse who was paying the alimony. These potential benefits gave divorcing couples the opportunity to bear some of the high costs of divorce, putting alimony at the center of divorce negotiations and a top consideration for legal decision makers.
Changes under new law
The Tax Reduction and Employment Act of 2017 eliminated the federal alimony deduction for alimony paid under divorce settlements entered into after December 31, 2018. Additionally, previously entered into divorce settlements may be subject to the new rule if a maintenance amendment agreement specifically states that the new law applies.
So how do divorcing couples know if alimony payments are still deductible on their state tax returns? It depends on whether and how your state follows federal tax rules. This can get complicated, but in general there are three options:
1. You apply the federal definitions of adjusted gross income or taxable income: Most states—but not all—use your federal adjusted gross income as the starting point for determining state taxable income. The federal alimony deduction reduced the payer’s federally adjusted gross income. With the removal of this deduction, if your state strictly adheres to federal regulations, you would also lose the alimony deduction on your state income tax return. A similar effect may occur for states whose starting point is federal taxable income, a derivative of adjusted gross federal income.
2. You’re following federal tax rules, but not until a certain date: If so, you’ll want to check how the state paints its compliance with federal laws. For example, if you live in a state that last changed before the change of federal law, alimony may still be deductible at the state level. Some of those states, including California and Massachusetts, have already made it clear that the child support deduction will remain.
By the way, if you live in Alabama, Arkansas, Mississippi, New Jersey, or Pennsylvania, you’ll need to examine the rules even more closely, as these states only selectively adhere to the federal income tax structure.
3. You Deviate From State Tax Laws: Despite all of the above, states are always free to enact their own state tax laws. Of course, AK, FL, NV, SD, TX, WA, and WY do not collect state income taxes, and NH and TN collect income taxes only on certain types of income. In the world of taxation there are always subtleties and exceptions; but there is more to the world of government taxation.
what it means to you
Despite the elimination of the federal alimony deduction, a state deduction may still be available. For couples with marriage and post-nuptial agreements, it remains to be seen what the possible effects of the change in the law will be. Given that these agreements may have established alimony payments assuming the old tax treatment, the change in federal tax law may also affect currently married individuals.
Simply put, maintenance planning may have become less important from a federal income tax perspective, but it can still be quite important from a state and local income tax perspective. In a sense, removing the federal deduction may cause some to overlook the tax angle altogether — a trap for the unwary in states and localities that still offer the deduction. Due to the complexity of state tax laws, we encourage you to consult with a financial advisor, attorney or accountant to determine how this new law may affect you.
Michael J. Nathanson, JD, LLM, is Chairman and CEO and Dawn Doebler, CPA, CFP®, CDFA®, is Senior Wealth Advisor at The Colony Group. Dawn is also one of the founders of Her Wealth®.
Comments are closed.