Divorce has always been messy financially, but it’s likely to become messier beginning in 2019, when the new alimony rules created by the 2017 Tax Cuts and Jobs Act go into effect. Couples, advisors, and lawyers are scrambling to understand the implications.
For divorces finalized on or before December 31, 2018, the person paying alimony may take an above-the-line deduction, which decreases gross income dollar for dollar by the amount paid. Alimony recipients must pay income tax on the alimony received. The new tax law upends that structure: For divorces finalized beginning January 1, 2019, payers will be unable to deduct alimony payments, and recipients will no longer pay income tax on them.
The full effect of the new law on clients considering divorce remains to be seen, but it is safe to say that much will depend on the individual circumstances of the couple. The change will likely be negative for most alimony payers come January 2019, since losing the alimony tax deduction could cost thousands of dollars each year.
The impact is less clear for recipients. In some ways, alimony recipients whose divorces are finalized after 2018 stand to benefit. They won't have to pay income tax on their alimony payments, and lower taxable income may bring other benefits, such as eligibility for health-care subsidies or federal assistance programs.
On the other hand, some alimony recipients may be better off under the current law. Taxation of alimony payments is likely to reduce the amount of alimony that payers can offer as part of a divorce settlement—and even if it doesn’t, it gives payers and their lawyers more ammunition to make the case for lower payments. So recipients may collect less, even considering the tax benefits they’ll see under the new law. Moreover, recipients will no longer be able to use alimony payments to make retirement account contributions, which must come out of taxable income.
There are other reasons for alimony payers and recipients alike to be concerned about the new rules. Divorce settlements may become harder to reach, potentially leading to drawn-out cases and higher legal fees for both parties.
Clients considering divorce should also consider the following:
Ultimately, the effects of the new alimony rules will depend on the respective financial situations of each divorcing couple and their willingness to come to an agreement. In general, however, it seems likely that more divorce cases will go to court rather than be settled, and some states may be forced to reframe their alimony guidelines to take the federal law into account. In the face of all of this upheaval, it’s especially important to have thorough conversations about alimony with divorcing clients—whether they’re on the paying or receiving end.
Should you have any questions regarding alimony and the new tax law, please feel free to contact the Pacific Life Retirement Strategies Group at (800) 722-2333 or send an email to RSG@PacificLife.com.
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