Under the current IRS tax code, spousal support is tax deductible by the payor and taxable to the payee. This means that the person paying spousal support is paying pretax dollars, which they can then deduct on their annual return. In other words, people paying alimony under the current law can deduct those payments—no matter how big the amount—from their income before calculating what they owe in taxes. A change in the tax law will eliminate this tax break for spousal support orders that are finalized after December 31, 2018.
Under the 2017 Bill, for divorces finalized in 2019 and thereafter, the payor can no longer deduct the payment of spousal support, and the spouse receiving support does not need to claim the support as income.
For decades, Americans paying spousal support to a former spouse have been able to deduct the payments from their taxes, providing a potentially generous tax break depending on the size of the payments and the gap in earnings between spouses.
This is because when it comes to spousal support, the paying spouse is generally the higher earner and therefore taxed at a higher rate. Similarly, the receiving spouse is typically the lower earner and taxed at a lower tax rate. So, when it comes to the spousal support dollars, under the old rule there are less taxes to pay resulting in more money available to the parties. Under the new rule, where there are more taxes to pay, the result is less money available to get the case settled.
Eliminating the benefit will hit certain types of divorced couples harder, primarily hurting those who earn vastly different amounts of income and are taxed at different rates. Under the current code, if the person paying spousal support earns substantially more than their former spouse, he or she generally negotiates a higher payment because the payer can deduct the full amount from his or her income and the former spouse, who earns less, pays a lower tax rate on spousal support payments. The new treatment takes away that benefit, putting pressure on high earners to pay more to support their former spouses—or hurting the lower-earning spouse, if the higher earner demands to pay less to make up for the lost tax break.
Lawyers warn that the loss of the alimony deduction could disproportionately hurt women, who are the more frequent recipients of alimony payments and who face a higher risk of income decline after divorce than men.
In many cases, the new tax law will mean less money for the spouse receiving alimony—or, at the very least, a major source of contention in negotiations between parties.
Financial planners say some spouses may choose to forgo alimony payments and instead accept more lucrative real estate, larger shares in tax-deferred retirement accounts or some complex combination of the two that maximizes tax advantages. The options include a Qualified Domestic Relations Order that sets up future payments to a lower-earning spouse from a higher-earning spouse’s retirement account, which would be taxed at the lower earner’s rate.
Middle-class and lower-income taxpayers have fewer of those assets—and less ability to recapture potentially lost benefits of the alimony deduction.