Among the many significant changes to corporate and individual tax brought about by the Tax Cuts and Jobs Act (“TCJA”) of 2017, some of the greatest impacts affect individuals involved in a divorce, particularly with respect to the tax treatment of alimony.
Prior to the new law, all spousal support payments that qualified as alimony were deductible by the payor and were identified as a source of taxable income to the recipient. Under the TCJA, pursuant to a separation agreement that cites the Act, alimony payments related to a divorce that is finalized or modified after December 31, 2018, are no longer deductible by the payor and cannot be treated as taxable income to the recipient.
The impending loss of the alimony deduction caused a considerable rush to finalize divorces in 2018. Many of the TCJA provisions that impact individuals sunset after 2025, but the elimination of the alimony deduction has no termination date.
The receiving spouse will no longer claim alimony as income and, thus, will not pay any income tax on the alimony payment. This sounds like good news for the receiving party, but due to the loss of deduction, the total money available to both spouses and children will decrease. Since the payor spouse usually has a higher level of income than the receiving spouse, the payor spouse is subject to a higher marginal tax rate than the receiving spouse. Hence, total alimony payments will be taxed at the higher rate of the payor rather than split to include the lower rate of the receiver.
Example
Let’s assume a spousal support payment of $5,000 per month. The payor spouse pays a marginal tax rate of 35%, and the receiving spouse’s tax rate is 28.5%.
| Spousal Support before TCJA | Spousal Support after TCJA |
|---|---|
| The payor spouse could deduct $60,000 off the top of his/her 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 (a-b) |
No deduction for the payor spouse. $21,000 paid in taxes on the previously deductible $60,000.
The receiving spouse will not pay income tax. No net savings. |
Divorcing parties with modest incomes will be most affected by the tax burden due to the loss of the alimony deduction. When child support is also taken into consideration, the ability to pay alimony may become more difficult.
For parties with high incomes, payment of alimony would still be highly dependent on the payor’s financial ability and the receiver’s need. Additionally, the amount of alimony payable is likely to decrease, given the higher tax rates applicable to total income.
TCJA has also taken away the opportunity of an unemployed spouse to make contributions towards an individual retirement account. Since the receiving spouse will no longer pay income taxes on alimony, eligibility for a retirement savings plan becomes questionable. Although the TCJA’s alimony provisions have been in effect for less than a year, it has had a significant impact already, not only for parties currently engaged in marital dissolution proceedings, but also for those contemplating commencing such a process.
© Copyright CBIZ, Inc. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.
“CBIZ” is the brand name under which CBIZ CPAs P.C. and CBIZ, Inc. and its subsidiaries, including CBIZ Advisors, LLC, provide professional services. CBIZ CPAs P.C. and CBIZ, Inc. (and its subsidiaries) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. CBIZ CPAs P.C. is a licensed independent CPA firm that provides attest services to its clients. CBIZ, Inc. and its subsidiary entities provide tax, advisory, and consulting services to their clients. CBIZ, Inc. and its subsidiary entities are not licensed CPA firms and, therefore, cannot provide attest services.