Tax Treatment of Alimony Payments Under GOP Tax Cuts and Jobs Act

Tax Treatment of Alimony Payments Under GOP Tax Cuts and Jobs Act

Federal Tax Law Eliminates Alimony Deduction

Congress passed the Tax Cuts and Jobs Act of 2017 (“TCJA”), with a promise to cut taxes for individuals and businesses while providing stimulus for the national economy. There were sweeping changes made in an attempt to reform the tax code, which included changes to individual tax rates and deductions.

Under the TCJA, signed into law on December 20, 2017, one of the more significant changes in this legislation is the discontinuation of the alimony deduction. Specifically, a spouse paying alimony (spousal support in California) to their spouse or partner can no longer deduct spousal support payments under federal tax law. Correspondingly, a spouse or partner receiving spousal support payments won’t be taxed for those payments. This change is applicable for agreements finalized after December 31, 2018.

While you may not be interested in learning more about the finer points of taxation, this change under the TCJA is important because it highlights the importance of understanding your finances throughout your marriage and before you divorce.

Here’s why …

Under old tax rules, permitting a higher-earning spouse to provide more money in the form of alimony for a lower-income spouse was thought to benefit the family because alimony payments were usually taxed at a lower rate for the recipient-spouse. Generally, for most families this meant more money would be available to the family. That incentive, which allowed spouses to negotiate a higher spousal support payment with the promise of a tax benefit for the spouse making the support payment, is now gone under the TCJA. Arguably, when couples are negotiating a spousal support order, there is less incentive to agree to a higher support payment since there is no tax benefit for the spouse being asked to pay spousal support.

The threat of a substantial drop in income to spouses and their family unit after divorce is a strong consideration for families struggling financially. In one study conducted by the National Bureau of Economic Research, “the family income of children whose parents divorce and remain divorced for at least six years falls by 40% to 45%.” The new tax rules may cause some couples to stay together because of the perceived financial hardship that may result after divorce.

According to a Pew Research Center study, there was a rise in the past decade of mothers staying home to care for their family. It’s not uncommon to find fathers staying home to care for family as well. In either case, when one spouse dedicates themselves to home and family their income level and career often takes a back seat to the priorities of the family and the higher-income earning spouse. Unfortunately, when these families face a significant life change such as divorce, the loss of income to the lower-income earning spouse can make the transition from divorce difficult, especially when children are involved. As a result, the recent elimination of the alimony deduction can make negotiating a settlement more problematic.

Understanding How Spousal Support is Determined in California

According to California Family Code Section 4320, a judge will consider the following factors to determine how much alimony a spouse is entitled to:

  • How much each spouse earns and if their income is sufficient enough to maintain the standard of living established before they split up.
  • Whether the supported spouse has marketable skills.
  • The future earning capacity of the supported spouse.
  • The ability of each spouse to pay support in terms of their earning capacity, income, assets, and standard of living.
  • Which obligations and assets were ordered or awarded to each party as part of the divorce.
  • How long the couple was married.
  • The age of each spouse.
  • The overall health of each spouse.
  • Whether there is a history of domestic violence in the relationship.

Dealing with Spousal Support Modifications

In California, when you obtain a spousal support modification you will need to show the court there has been a “material change in circumstances” since the initial spousal support order was made.

The recent change under the TCJA became effective for divorce agreements executed after December 31, 2018. It also applies to divorce agreements executed on or before December 31, 2018, and modified after such date, if the modification instrument expressly provides that the TCJA provisions will apply to the requested modification. So, if you modify a spousal support order after January 1, 2019, it will be deductible to the payor-spouse and included as income to the payee-spouse provided the post January 1, 2019 order specifically states it is deductible to the payor-spouse and included as income to the payee-spouse.

The change is not retroactive, which means TCJA provisions will not apply to divorce agreements already in place before the end of last year. If your divorce was finalized before Jan 1, 2019, and you were paying spousal support, your situation does not change. However, if you are receiving spousal support, and your divorce is still pending, the payor-spouse will not be able to deduct spousal support payments to the payee-spouse.

California Tax Treatment of Spousal Support

While the new federal TCJA changed tax treatment for alimony payments in 2019, California still allows a deduction for the spouse who pays alimony and inclusion to income for the recipient spouse. In order to take the tax deduction, California requires alimony (spousal support payments), to meet these requirements:

  • Payment is in cash (including checks or money orders).
  • Divorce agreement does not say that the payment is NOT alimony.
  • You and your former spouse are not members of the same household when you make the payment.
  • There must not be any liability to make the payment after the death of your spouse or former spouse.
  • Your payment is not treated as child support or property settlement.
  • A joint return is not filed

Other Important Changes Under the TCJA

Congress passed the TCJA with a promise to cut taxes for individuals and businesses while providing stimulus for the national economy. There were sweeping changes made in an attempt to reform the tax code, which included changes to individual tax rates and deductions.

As we discussed earlier, payments originally considered alimony or separate maintenance (legal separation) payments were deductible by a payor-spouse and included as part of income of the payee-spouse, unless the parties expressly agreed that the payments would not be deductible or included as part of income to the payee in an agreement. There were other important changes to the tax code for families to consider:

The SALT Cap:

State and local tax deduction is capped at $10,000. This includes both state income or sales taxes and property taxes.

Casualty Loss:

There is no casualty loss deduction unless it is a federally declared disaster. You must include FEMA number and property location to claim the loss.

Mortgage Interest Deduction:

A mortgage modification with a cash out, even if just for closing costs, amy result in a loss of grandfathered $1millinon de3bt limit and become a $750,000debt limit. No home equity interest deduction can be claimed unless taxpayer documents expenses to build or improve the home.

Child Tax Credit:

In 2018, if claiming child tax credit, taxpayers have to provide social security numbers for qualifying child.

Elementary and Secondary Schools Now Eligible for 529 Plans:

Beginning with 529 plan distributions made after December 31, 2017, eligible institutions now include elementary and secondary schools.

There are some TCJA provisions that are temporary (effective from 2018 through 2025). However, new rules regarding spousal support are now a permanent part of the tax code.

It’s unclear what the overall impact the TCJA will have on the U.S. economy. The American Academy of Matrimonial Lawyers (AAML), an organization comprised of some of the nation’s top family law attorneys, initially approved a national resolution opposing efforts to repeal the alimony tax deduction. Madeline Marzano-Lesnevich, president of the AAML stated, “Alimony is an essential tool that has enabled countless spouses to adjust to a dramatically altered economic reality. The financial security provided to families by spousal support is a valuable resource that needs to be further strengthened and not diminished by our representatives.”

What has always been clear, however, is that if you are going through a divorce you will need to understand your financial position and the implications of these tax code changes. It’s less likely that a high net worth spouse will be negatively impacted by the elimination of the alimony deduction. Meanwhile, stay-at-home parents, middle-and-lower income families and any spouse earning substantially less income than their spouse will need to have a better understanding of exactly how these tax changes will impact their finances after divorce.

You should contact a qualified accountant and/or tax attorney to discuss these changes to obtain their perspective on the specific application of recent tax changes to obtaining a divorce.

Consult with a Los Angeles Divorce Attorney Today

Do you have more questions about how the new tax law will impact your divorce agreement? Do you need help preparing for your divorce? If so, you should get in touch with our team of experienced family law attorneys to discuss your legal options.

At Castellanos & Associates, APLC, we are dedicated to helping clients in the greater Los Angeles area with their divorce cases. We can assess your situation and build a strong legal strategy that will protect your rights and interests. Let us get to work for you!

Call (323) 212-5599 to schedule your free consultation with one of our spousal support lawyers.