Among the many significant corporate and individual tax changes implemented by the Tax Cuts and Jobs Act (“TCJA”) of 2017, some of the largest impacts affect individuals involved in a divorce, particularly with respect to tax treatment of maintenance payments.
Prior to the new law, all spousal support payments that were considered alimony were deductible by the payer and identified as a source of taxable income by the recipient. Under the TCJA, alimony payments in connection with a divorce finalized or modified after December 31, 2018, pursuant to a separation agreement that references the Act, are no longer deductible by the payer and cannot be treated as taxable income to the recipient .
The threatened loss of the alimony deduction triggered a significant rush to finalize divorces in 2018. Many of the TCJA provisions that impact individuals expire after 2025, but the alimony deduction elimination does not have a termination date.
The receiving spouse is no longer entitled to alimony as income and therefore does not have to pay income tax on the alimony payment. This sounds like good news for the receiving party, but the elimination of the deduction reduces the total amount available to spouses and children. Because the paying spouse typically has a higher income than the receiving spouse, the paying spouse is subject to a higher marginal tax rate than the receiving spouse. Therefore, the entire alimony payments are taxed at the payer's higher tax rate and are not divided to include the recipient's lower tax rate.
Example
Let's assume a spousal support payment of $5,000 per month. The paying spouse pays a marginal tax rate of 35% and the receiving spouse's tax rate is 28.5%.
| Spousal support before TCJA | Spousal support under TCJA |
|---|---|
| The paying spouse could deduct $60,000 from their income, resulting in a tax savings of $21,000 (A).
The receiving spouse would pay $17,100 (B) as income tax. Net Savings: $3,900 (from) |
No deduction for the paying spouse. $21,000 in taxes were paid on the $60,000 previously deductible.
The receiving spouse does not pay income tax. No net savings. |
Divorcing parties with low incomes will be hit hardest by the tax burden due to the loss of the alimony deduction. When child support is also taken into account, the ability to pay support may become more difficult.
For high-income parties, the payment of alimony would still be heavily dependent on the financial capacity of the payer and the needs of the recipient. In addition, the amount of maintenance payable is likely to decrease due to higher tax rates on overall income.
TCJA also removed the ability of an unemployed spouse to contribute to an individual retirement account. Because the receiving spouse no longer pays income tax on support, eligibility for a retirement plan becomes questionable. Although the alimony provisions of the TCJA have only been in effect for less than a year, they have already had a significant impact, not only for parties currently engaged in marital dissolution proceedings, but also for those considering initiating such proceedings.
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