Taxpayers have gotten used to a huge set of new provisions that immediately took effect as 2018 began following the tax reform laws. Between new tax rates, different bracket thresholds, and major changes to standard and itemized deductions, those who haven't been paying attention to their taxes lately are in for a big shock when they start preparing their returns early next year.
A couple of the provisions of the tax bill had some delays built into them. One of the most important such provisions has to do with how alimony payments between divorced ex-spouses get taxed. For those who are currently going through a divorce, the timing of how things work out over the next four months could make a huge difference in how any payments get taxed starting next year.
The way that alimony currently gets treated for tax purposes
Even under current law, most payments between divorced ex-spouses are treated as being tax-neutral. For instance, if you're divorced and have children and you make payments to your ex-spouse for child support, those payments don't have any immediate tax consequences. They're not treated as income to the ex-spouse who receives them, nor does the paying ex-spouse get a deduction for the payment. The same tax treatment applies to payments that are characterized as maintenance, with neither ex-spouse having taxable income or a deduction.
However, for whatever reason, payments between ex-spouses that are treated as alimony are handled in a much different way. For 2018, if you receive an alimony payment from an ex-spouse, then you have to include it in your taxable income. If you're the one paying alimony, then you get a deduction for the amount you paid. You don't even have to itemize your deductions in order to write off your alimony payments.
Surprise! A big change for alimony
Tax reform changed these rules, with a one-year delay. Starting for 2019, if you get divorced, then it doesn't matter how payments between ex-spouses are treated in a divorce decree. All payments, including alimony, will be tax-neutral, with no income or deductions available for either ex-spouse.
Whether that's a good or bad thing depends on your situation. Treating alimony the same way as other divorce-related payments is a lot easier to keep straight. But it also removes the ability to shift some income from a high tax rate to a low tax rate. For instance, in the common situation in which a higher-income earner pays alimony to a lower-income earner, the deduction under current law is worth more to the higher-bracket payer than the lower-bracket recipient pays in taxes on the income. In hard-fought divorces, ex-spouses might not be willing to work together to realize those gains, but sometimes, advisors can convince them of the opportunity to get what's essentially free money from the IRS.
For the IRS, getting rid of alimony deductions takes away a potential source of fraud. It's common for the number of people claiming alimony deductions not to match up with the number of returns reporting the corresponding alimony income. The most recent statistics available show a more than $2 billion disparity in income and deductions, with hundreds of thousands of returns involved.
The clock is ticking
If you really want the benefit of the current alimony rules, though, it's not too late. Anyone who was divorced in or before 2018 will keep getting taxed under the old rules, even once the new ones take effect. Those who wait until 2019 or later to divorce won't have a choice; they'll have to follow the new rules.
What that means is that for those who are currently undergoing divorce proceedings -- or thinking about it -- time is running out for maximum planning efficiency. If you want to be able to characterize alimony payments as deductible for tax purposes, then you need to get moving, because Dec. 31 will come a lot faster than you expect.