Last year, we explored the Tax Cuts and Jobs Act of 2017 ("TCJA"), offering a holistic view of its ambitions and implications for divorcing spouses. It's unclear if there will be any changes made to the TCJA in the coming year.
This article revisits the TCJA to explore its impact on divorce and settlement agreements. We hope this will get you thinking about some essential tax considerations when planning for divorce.
Repeal of Alimony or Separate Maintenance Payments
One of the more significant changes under the TCJA deals with the repeal of the deduction for alimony and separate maintenance payments.
Specifically, the TCJA changed the taxation of alimony or separate maintenance payments as follows:
- Alimony or separate maintenance payments under a divorce or separation instrument executed after 2018 are no longer deductible on a federal return by the payor spouse; and,
- The receiving spouse will not have to declare the alimony or separate maintenance payments as income in their federal income tax returns.
Internal Revenue Service Publication 504 ("IRS Publication 504"), which is for use in preparing 2019 returns, describes the particular tax rules applicable to Divorced or Separated Individuals.
According to IRS Publication 504, payments generally qualify for federal alimony tax treatment under the TCJA for divorce or separation instruments executed after December 31, 2018.
In some instances, an agreement signed before 2019 but modified after 2018 may also fall under the law.
Specifically, Internal Revenue Service Tax Topics, Topic No. 452 ("IRS Publication 452") states as follows:
"You can't deduct alimony or separate maintenance payments made under a divorce or separation agreement, 1) executed after 2018, or (2) executed before 2019 but later modified if the modification expressly states the repeal of the deduction for alimony payments applies to the modification. Alimony and separate maintenance payments you receive under such an agreement are not included in your gross income."
For further clarification, please refer to IRS Publication 452.
Family law practitioners and their clients will need to consider what impact will the elimination of the deductibility of alimony payments will have when negotiating settlement agreements. In some cases, there may be little incentive for the higher-income earning spouse to maximize spousal support payments to the lower-income spouse because of the deduction's loss.
In other cases, those with existing agreements entered into before December 2018 may attempt to modify a current instrument based on changed circumstances. However, it's unclear whether the change in the tax law would justify the change.
For example, a high-income earning spouse may have previously sought to maximize spousal support payments so they could receive the benefit of the tax deduction, especially as these payments relate to child support payments and property distributions. TCJA changes to alimony or separate maintenance payments will cause family law practitioners and their clients to rethink settlement agreements.
Requirements for Alimony Tax Treatment Under the TCJA
To be considered alimony (spousal support), payments are characterized based on specific requirements. As you can see, the Internal Revenue Code and the TCJA refer to "alimony and separate maintenance payments" for the characterization of payments as qualifying for federal tax treatment. Based on the TCJA's elimination of the deduction for alimony or separate maintenance payments, alimony tax treatment now means that these payments are no longer deductible by the paying spouse and not included in the recipient's gross income.
As you can see, the federal tax treatment of alimony or separate maintenance payments is a term of art with distinct requirements. You can delve deeper into IRS Publication 452 to better understand the particular requirements for alimony tax treatment imposed under the TCJA.
Generally, payments qualify as alimony or separate maintenance payments if all of the following requirements are satisfied:
- Payments must be in cash (including checks or money orders);
- Amounts received under a divorce or separation instrument;
- Spouses file taxes separately;
- Spouses live in a separate residence;
- Payment not treated as child support or property settlement;
- Not have an agreement that says the amount is something other than alimony; and,
- There should not be an agreement that payment would continue after the death of either party.
Alimony in California Divorce
According to the California Franchise Tax Board, California does not adhere to the changes applied to alimony payments under the TCJA. While the TCJA repealed the federal income tax deduction for certain alimony payments, California's income tax treatment of spousal support payments allows the paying spouse to deduct spousal support for state income tax purposes. Spousal support payments to the payee spouse are taxable income to the recipient under state law.
The Effects on Individual Retirement Accounts
The TCJA outlines changes for traditional individual retirement accounts ("IRA"), which stand to affect alimony further. The TCJA asserts that:
- If a paying spouse transfers a portion of their pretax IRA funds (Traditional IRA) to satisfy alimony via a property division agreement or qualified domestic relations order ("QDRO"), for purposes of the TCJA, the transfer into a pretax retirement savings account for the benefit of the receiving spouse is not considered a taxable transfer;
- A recipient spouse is responsible for taxes due from alimony payments withdrawn from an IRA;
- A receiving spouse cannot invest alimony payments into an IRA, even if it is their sole income source.
There are specific rules for using a retirement account to satisfy alimony obligations. Getting help from a certified public accountant or CPA to discuss your options based on these new tax rules is strongly encouraged.
TCJA Effect on Divorce and Child Support
Further divorce-related tax changes exist under the TCJA. Beyond alimony, the TCJA affects:
- Divorce-related legal fees: You cannot deduct legal fees and court costs for getting a divorce under the TCJA. Please read IRS Publication 504 to obtain additional information.
- Child support: Child support payments are never deductible by the paying spouse and is not considered taxable income to the payee.
The Future
Although some provisions of the TCJA are temporary, the repeal of the alimony deduction is permanent. We still don't know if there will be any changes made to the TCJA. Nevertheless, it's essential to discuss any tax considerations with your family law practitioner.
We would also urge you to obtain advice from a qualified accountant or certified tax professional to help you understand just how these changes could impact your divorce.
If you need help with a divorce in Los Angeles, please contact one of our attorneys today at (323) 655-2105.
Disclaimer: The information contained in this blog post ("Post") is provided for general informational purposes only and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Castellanos & Associates, APLC, or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this Post should act or refrain from acting based on any information included in this Post without seeking appropriate legal advice on the particular facts and circumstances at issue from a qualified attorney licensed in the recipient's state, county, or other appropriate licensing jurisdiction.