By: Minh Luong
The Tax Cuts and Jobs Act of 2017 (“TCJA”) was recently approved by Congress on December 20, 2017 and signed by President Trump on December 22, 2017. TCJA obviously impacts business taxes. Sophisticated business people will look at ways to lawfully avoid paying taxes by taking advantage of new tax laws.
TCJA also affects family law. Specifically, TCJA will change the way alimony/spousal support will be taxed. A prudent person should also look at lawful ways to avoid or minimize taxes based on the provisions of the new tax law.
Alimony, also known as spousal support, is payment from one spouse to another dependent spouse to help support and maintain a living standard during or after the divorce. In California, for long-term marriages that last 10 years or more, a spouse may receive alimony until the death of either party, or until the party receiving alimony remarries (Cal. Fam. Code § 4337). The alimony payment can endure for an indefinite number of years, so it can be substantial. Therefore, the tax consequences may also be substantial.
In the past, the alimony payer generally deducted taxes on alimony payment, and the recipient’s alimony was taxed as income to the recipient. The new TCJA has repealed that general allocation of who pays taxes. Those who pay alimony can no longer deduct alimony payments from their taxable income and those who receive alimony do not have to include it in their taxable income. There will be a substantial increase in taxes for those who pay alimony.
When will the new TCJA be effective? Timing is everything.
Existing alimony agreements will be grandfathered in. In other words, the TCJA will not affect alimony taxes for these individuals and the payor would still get a tax deduction. However, there are additional requirements to get the tax deduction. Some of these requirements include: the ex-spouses may not file a joint return with each other; the payment must be in cash; the payment is to a former spouse made under a divorce or separation document; the separation document designates the payment as alimony; and the payment is not treated as child support or a property settlement.
If there is an existing alimony agreement, the parties can modify their spousal support after December 31, 2018 to reflect the new federal law. The parties can choose to have the support payment non-deductible to the payor and can choose to have the payment non-taxable to the recipients of spousal support. The parties would need to specifically state in writing that the new law is to apply.
If there is no existing alimony judgment, but the couple sign a marital settlement agreement before this year ends, December 31, 2018, then their alimony would be tax deductible to the payor. If you are thinking of divorce and must pay alimony, you may want to contact an attorney to expedite the process. If the judgment is finalized before the year ends, it could potentially save the payor a lot of money in the long term. On the other hand, if you are going to receive alimony, you may want to sign after the year end, so that you will not be liable for taxes. Alternatively, you can hire an attorney to negotiate with the other party for a higher alimony in exchange for finalizing the settlement before the year ends. This would save the payee taxes for many years.
If the settlement agreement or judgment is signed after December 31, 2018, the paying spouse would no longer receive the benefit of deducting taxes. The TCJA provision on alimony would take effect for divorce and separation agreements signed after December 31, 2018.
Prior to TCJA, many couples have executed a prenuptial agreement allocating that the payor can deduct alimony and the receiver will pay taxes. The law is uncertain as to the outcome and the legality of such provisions. It is probably unlikely that the prenuptial agreement will escape tax liability and the TCJA. However, if you do have a prenuptial agreement, you should contact an attorney to add language to the prenuptial agreement that accounts for the uncertainty. Alternatively, the attorney can modify the existing prenuptial agreement to account for the tax liability.
Understanding the new tax law can have a significant impact on negotiation during a divorce settlement. If you’re concerned about paying unnecessary taxes, in addition to paying alimony, you should contact an attorney for legal advice.