You may have heard that alimony payments are no longer deductible for federal income tax purposes. But you may still be able to deduct it from your state income tax. Here’s What You Need To Know If You Are Freshly Divorced And Filing Taxes.
You may have heard that alimony payments under newly enacted divorce agreements are no longer deductible for federal income tax purposes. This long-term deduction, which has been in place for around 75 years, was abolished by one of the most controversial and widely published provisions of the Tax Cuts and Jobs Act of 2017.
With so much attention focused on losing the federal allowance, there is one related consideration that has received very little attention: maintenance payments that are no longer federally deductible can still be deducted for state income tax purposes. This can be a very important point for couples looking to divorce, especially in high-tax areas where the state tax deduction has a higher value.
The federal maintenance allowance used to be the top priority
The federal alimony allowance has long been an integral part of divorce planning. The old rule allowed the maintenance payer to deduct their payments while the recipient paid income tax on any maintenance received. The result gave separating couples the opportunity to shift their taxable income from the spouse with the higher income to the lower one. In cases where the maintenance was substantial, this tax treatment provided the two individuals with a valuable opportunity to save on all of their federal income tax bills.
The withdrawal also took some of the sting out of the ex-spouse who paid the alimony. These potential benefits have allowed divorcing couples to share some of the high costs of divorce, placing the alimony allowance at the center of divorce negotiations and one of the main considerations of legal decision-makers.
Changes according to the new law
The Tax Cuts and Jobs Act of 2017 abolished the federal alimony allowance for alimony payments under divorce settlements that were entered into after December 31, 2018, and new law applies.
So how do divorcing couples know if the alimony is still deductible on their state tax return? It depends on whether and how your state complies with federal tax rules. This can get complicated, but in general there are three options:
1. You apply the state definitions of Adjusted Gross Income or Taxable Income: Most, but not all, states use your federal adjusted gross income as the starting point for determining the state’s taxable income. The federal alimony allowance reduced the payer’s federally adjusted gross income. With this deduction removed, if your state strictly adheres to federal regulations, you would also lose the alimony deduction on your state income tax return. A similar effect can occur for those states whose starting point is the taxable federal income, a derivation of the adjusted gross federal income.
2. They are governed by federal tax rules, but only from a certain date: If so, you want to check how the state quantifies its compliance with federal law. For example, if you live in a state that last adjusted before the federal law changed, the child support allowance may still be available at the state level. Some of these states, including California and Massachusetts, have already made it clear that the alimony deduction will remain in place.
Incidentally, if you live in Alabama, Arkansas, Mississippi, New Jersey, or Pennsylvania, you need to check the rules even more carefully, as these states only adhere to the federal income tax structure in some cases.
3. You Deviate from Federal Tax Regulations: 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 levy state income taxes, and NH and TN only levy income taxes 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 maintenance allowance, a state allowance may still be possible. The possible effects of the change in the law remain to be seen for couples with marriage and post-marriage contracts. Given that these agreements may have established maintenance payments assuming the old tax treatment, the amendment to the federal tax law may also have implications for those currently married.
Simply put, maintenance planning may have lost its relevance from a federal income tax perspective, but it can still be very important from a state and local income tax perspective. In some ways, waiving the state deduction can actually lead some to completely overlook the tax aspect – a trap for the unwary in states and communities that still offer the deduction. Because of the complexities of state tax laws, we encourage you to consult a financial advisor, attorney, or accountant to learn 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®.
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