The new tax law passed by Congress in late 2018 and signed into law by President Donald Trump does a lot of things. For example, if you’re fortunate enough to leave behind a huge estate, your heirs will now get the first $10 million tax free. In addition, the corporate tax rate on income for businesses has been cut dramatically.
Of course, Uncle Sam has to find a way to pay for these cuts. One of these ways will affect divorces dramatically: the elimination of the alimony deduction.
In a nutshell, before the new tax law, spouses paying alimony to an ex could deduct these payments from the amount of income they were taxed on. This would often be enough to move that spouse into a lower tax bracket, which would result in all of his or her taxable income getting taxed at a lower rate. The spouse receiving alimony, however, would pay income tax on those payments.
This is flipped under the new law. The paying spouse can no longer deduct alimony payments, while the recipient spouse gets his or her alimony tax free. This is a good deal for the government because the spouse paying alimony is generally in a much higher tax bracket than the spouse receiving it, meaning the government will make more money by increasing the paying spouse’s taxable income than it did from taxing the receiving spouse on the payments.
It will, however, have a massive effect on divorces. That’s because many states have “baked” the tax deduction into the formulas they use to calculate someone’s alimony payments. Judges also take tax deductibility into account when calculating alimony in order to bring about a quicker settlement. The loss of the deduction will no doubt make it harder for divorces to settle quickly.
Also, now that alimony is not deductible, it may be harder for someone to make alimony payments while still paying as much in child support or school expenses. It could even make some couples feel they need to stay together when that’s not the best thing for either spouse or the children.
This won’t apply retroactively. It applies to divorce and separation agreements signed on or after Jan. 1, 2019.
The alimony deduction is the provision most closely connected to the divorce process. But the new law includes some other controversial new revenue sources that could impact divorces too.
For example, if you’re paying state and local taxes, including property taxes, you can now deduct only the first $10,000 you pay each year, when you used to be able to deduct it all. This is bad news if you live in a city or state with high tax rates. If you have a home mortgage, you used to be able to deduct any interest you paid on that loan each year. Now you can deduct only the interest you pay on home loans of up to $750,000. Most of us don’t have mortgages that big, but if you live in an expensive part of the country, you could be hit hard.
These changes don’t directly relate to divorce, but they could impact the “gross income” that a court uses to calculate the level of support you have to pay, and they could also impact the real value of your home, which could complicate the divorce process further.
There’s a lot of other things in this complicated new law that could create traps we don’t even know about yet. To get a better handle on how the tax law could affect your divorce, contact us today.
