For the past 70 years, alimony payments have been tax deductible by the payer and taxable as income to the recipient. The Tax Cuts and Jobs Act, enacted in 2017, has altered that equation, which can be a game changer for divorcing couples trying to work out their financial arrangements. A major fallout of this new legislation could be to reduce couples’ net joint income after a divorce. However, in community property states like Arizona, the effect can be significantly reduced.
Prior to the TCJA, a paying spouse’s tax deduction resulted in a “divorce subsidy” — that is, a general tax savings that benefited both spouses. The paying spouse was usually in a higher tax bracket, so the alimony deduction allowed proportionately more of his or her income to be devoted to spousal support. This benefited both parties, since although alimony payments were taxable, the recipient’s lower bracket meant the tax bite was less.
With this deduction gone, more strain will be put on the payer’s resources, which could result in lower awards of alimony payments since there will be a smaller pool of money to divide. For example, a payer who could afford alimony of $100,000 a year because 35 percent of it was deductible may now be more strapped for cash. This would work to the detriment of the recipient, since any gain realized by not paying taxes on alimony may be insufficient to overcome the reduction in payments.
The effect of this change in the federal tax law may be felt less in a community property state like Arizona, where it is possible to make spousal support part of the divorce settlement. A property division agreement that transfers funds from one spouse to another — and specifies that that they are not alimony payments — will exempt those funds from the TCJA’s provisions. This is true whether the payments are made in lump sum or in installments.
The TCJA applies to alimony decrees entered on or after January 1, 2019. If you have an older decree, the tax treatment remains the same. If that earlier decree or agreement is modified on or after that date, the TCJA applies only if the modification expressly so provides.
If you would like to discuss how to manage your spousal support, contact an experienced family lawyer in Arizona. The Law Office of Phil Hineman, P.C. provides reliable guidance and representation in family law matters. Call me today at (928) 224-3230 or contact me online to schedule a consultation.