Congress passed the “Tax Cuts and Jobs Act” in late 2017. The legislation can be found on the House Ways and Means website.
The Act changes the tax treatment of spousal support (or “alimony”) payments in one important way. Under the new rules, alimony is no longer deductible for the payor, and money received as alimony is no longer taxable income for the payee (having already been taxed as the payor’s income). The new rules apply to divorces finalized after December 31, 2018. Existing settlement agreements are grandfathered in and are therefore unaffected.
Essentially, the prior rules allow divorced couples to shift taxable income from the payor to the payee. As a rule, alimony is a series of payments from the ex-spouse with higher income to the ex-spouse with lower income, and being able to shift the income to payee’s (presumably lower) tax bracket allows ex-spouses to lower the overall tax liability arising from the income being paid as alimony.
Under the old rules, for income tax purposes, alimony was deductible by the payor and includible in the gross income of the payee. However, simply labeling a payment as “alimony” does not mean it will be treated that way for tax purposes. Regardless of its designation or by court order or agreement between divorcing spouses, to be treated as alimony for tax purposes, the requirements of Internal Revenue Code section 71(b) must be met. Alimony is any payment in cash if:
- The payment is made to or on behalf of a spouse under a divorce or separation decree.
- The divorce decree is silent as to whether the payment as is not includible in gross income or allowable as a deduction. This means that if the parties do not want a payment to be treated as alimony, language in the instrument that states that it is not includible or deductible will negate its tax status as alimony.
- The payee spouse and the payor spouse are not members of the same household at the time of payment.
- There is no liability to make this payment after the death of the payee spouse.
The requirement that alimony be paid in cash means it can only be made in cash, check or money order. Because of this limitation, a transfer of property or services to the payee spouse is not considered an alimony payment for tax purposes.
Front Loading Alimony: Under the old rules, because alimony payments were deductible to the payor spouse, there was the temptation on his or her part to “front load” or make excessive payments in the early years of the alimony term to maximize deductions in those years. Then in later years, the payments would be much less.
What Does it Mean?
Many experts think that the change to the tax treatment of alimony payments will make divorce matters even more litigious and difficult to resolve by removing a key tool in negotiating cases with tax planning.
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