Note: For more information on financial planning and divorce, see our recent report from behavioral scientist Sarah Newcomb, The Big Split: Minimizing Conflict in Divorce Financial Planning.
Q: Can I still deduct my alimony payments?
A: The Tax Cuts and Jobs Act changed the way alimony is taxed. However, if your alimony payment is part of a divorce agreement entered into before December 31, 2018, you will most likely not be affected by the new tax laws and you will still be able to deduct your alimony payments as an over-the-counter deduction.
What is alimony? Alimony or spousal support is intended to mitigate the consequences of a divorce for the less earning spouse. The regular payments help the low-income earner maintain the same standard of living that he or she was accustomed to during the marriage. Additionally, alimony payments are part of a divorce agreement and do not include voluntary or property maintenance payments, according to IRS Publication 504. The payments may be temporary or temporary or more permanent in nature, depending on the agreement.
Alimony is not the same as child support. Tax laws regarding child support payments do not change: the payer cannot deduct the payments and therefore they are not taxable to the recipient.
What changes? This is how it has worked (for decades): The former spouse who pays alimony can deduct it from gross income to calculate their adjusted gross income. (Instead of being on page 1 of Form 1040 as in the past, deductions above the deduction are now on a separate form called Schedule 1.) The recipient then pays taxes on the alimony received.
If you were divorced before December 31, 2018, there will be no change to the way your alimony payments will be taxed this year or in future years (unless you elect to change the tax treatment of your existing ones divorce agreement).
However, if your divorce agreement was negotiated in the last few weeks (or you opted for the new tax treatment), alimony will be paid with after-tax dollars and the recipient will pay no taxes on it.
Why? In general, shifting the tax burden to the payer results in more money being paid in taxes overall. (The Joint Committee on Taxes estimates the change will raise $6.9 billion over 10 years.) The reason for this is that the higher-income spouse is presumably the one who pays alimony and the spouse With the higher income, you are likely to be in a higher tax bracket. (If you and your former spouse are in the same tax bracket, your alimony payment probably won't be as high.)
Here is an example. Let's say $1,000 per month is paid to a former spouse by a higher-earning ex-spouse. If the payer is in the 32% tax bracket, he or she can save $3,840 in taxes by deducting the $12,000 paid. The recipient — let's say he or she is in the 22% tax bracket — then pays $2,640 in taxes on the $12,000.
However, under the new rules, the higher-earning spouse will pay the full $3,840 in taxes. Therefore, under the new rules, the former spouses will pay $1,200 more in taxes on $12,000 ($3,840 – $2,640 = $1,200).
What impact will the new laws have on payers? This change will increase the dependent's taxable income, which could push them into a higher tax bracket. This could also impact the payer's eligibility for other credits and deductions.
If the person paying child support is a custodial parent, the new law could also result in less financial assistance available to prospective students who apply for assistance through the Free Application for Federal Student Aid. (The form uses tax returns from prior years, so this only applies to students whose parents divorced in 2019 or later and are applying for assistance for the 2021-22 school year.)
What impact will the new laws have on the recipient? The biggest potential downside to the recipient, in my opinion, is that the alimony payer's tax deduction has existed for decades and has likely been taken into account in determining the amount of alimony the alimony payer can afford. Some divorce experts believe that eliminating the payer deduction in many future divorce settlements could result in lower alimony payments because more of the available money goes toward taxes.
Another potential downside to the recipient is that taxable support was considered qualified income for making an IRA contribution and is unlikely to be covered by the new laws (although I have not yet seen an IRS ruling on this issue).
However, a potential benefit is that the alimony recipient may be eligible for more tax credits that are phased out at certain adjusted gross income thresholds because the alimony is no longer considered taxable income. For example, it will be easier for the dependent to qualify for the newly expanded $2,000 partially refundable child credit and/or the $500 dependent who is not an eligible child. (Eligibility for this is based on adjusted gross income.)
Another potential benefit is that if the recipient is a custodial parent, a prospective student may also be eligible for more financial aid as well as the American Opportunity Tax Credit or the Lifetime Learning Credit.
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