The recently passed tax-reform measure changed a lot of things about the federal income tax system. Nearly every taxpayer will see a different rate structure on his or her income, along with key amendments to tax deductions and credits that could result in much different tax liabilities in 2018 than in past years.
One change resulting from tax reform won't affect as many people, and the provision won't come into effect until 2019. Nevertheless, for divorced couples making alimony payments, the new rules under the just-passed tax law scheme involves upwards of $10 billion annually, with dramatic tax implications both for those pay alimony and for those who receive it.
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The old rules governing alimony payments
Under current law through the end of 2018, different types of payments between divorced spouses are treated differently. Money that one ex-spouse pays for maintenance or child support has no tax consequences, meaning the paying spouse can't deduct it and the receiving spouse doesn't have to include it as income.
However, if a payment between two ex-spouses is characterized as alimony, it's taxed completely differently. For alimony, paying ex-spouses get to deduct the payment from their tax returns. The receiving ex-spouses have to treat the payment as income on their returns. Any alimony income is included in gross income, and any alimony payment is allowed as a downward adjustment to gross income that you don't have to itemize to take.
What tax reform did
Beginning in the 2019 tax year, the treatment of alimony will change. Thereafter, all payments between divorced ex-spouses will be the same: No one will get a deduction or have to treat the money as taxable income.
The change definitely makes things simpler. Under current law, there are planning opportunities available for couples who are willing to work together. That's not always possible in a divorce situation, but if the paying ex-spouse is in a higher tax bracket than the receiving ex-spouse, then characterizing payments as alimony has the benefit of reducing the two taxpayers' total tax liability. Meanwhile, if the paying ex-spouse is in a lower bracket, then characterizing payments as maintenance or support avoids subjecting the money to a higher tax burden.
Part of the reason for the change might also stem from reporting disparities on tax returns. For instance, during the most recent year for which tax information is available, the IRS reported that almost 600,000 taxpayers claimed deductible alimony payments, with the total deduction amounts adding up to $12.35 billion. You'd expect every dollar of deductible paid alimony to get matched by a taxable dollar of received alimony on the other side. Yet only $10.08 billion in alimony income was reported during that year, and just 414,000 receiving ex-spouses put those payments on their returns. That makes the IRS suspicious of alimony deductions.
Still, the amounts involved can be fairly sizable. When you do the math, the numbers work out to an average of $20,613 on the paying side, and $24,316 on the receiving side. Those amounts can make a huge difference to total taxable income in both directions.
Already divorced? Don't worry
Obviously, those who have already divorced didn't have a chance to plan for a big legal change like this, and so there were many concerns that the change in the law would unfairly affect those who've already reached divorce agreements. Accordingly, the new provisions won't affect those who get divorced or sign a separation agreement before the beginning of 2019.
Despite the greater simplicity, not everyone is happy with the change. Advocates for lower-earning ex-spouses argue that allowing higher-earning ex-spouses to deduct alimony payments often resulted in larger payouts for their clients. Under the new rules, the loss of favorable tax shifting could lead to smaller settlements.
For now, divorcing couples can continue to plan under the old rules. Come 2019, however, they'll have no choice but to deal with the changes that tax reform imposed on payments between ex-spouses.
