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Starting Jan 1, 2019, the long-standing tax rules associated with alimony have significantly changed, and alimony is no longer tax deductible by the payer; nor is it taxable to the receiver. The new law, however, does not apply retroactively. That means that if you signed your Marital Settlement Agreement and MSA and/or your divorce was finalized before December 31, 2018, you will be grandfathered under the old law.
Here is what has changed:
1. Commencing 1/1/19, alimony is no longer tax deductible by the payer.
Alimony is no longer tax deductible by the payer. Paying spousal support had long been one of the best tax deals around for the payer. Before the TCJA, ex-spouses who paid alimony were able to deduct those payments, dollar for dollar, from their adjusted gross income. These rules were meant to encourage generosity in alimony payments by giving the payer a tremendous incentive. Negotiating the alimony case will now be a whole new ball game.
2. Commencing 1/1/19 alimony is no longer taxable to the receiver.
Alimony is no longer taxable to the receiver. Before the TCJA, the recipient of alimony was taxed on the alimony received just as if it were ordinary income (i.e. salary, wages). These new rules, however, make alimony look more like child support: a tax "wash".
3. Qualifying under old rules
In order to qualify under the old rules, the parties must have had their PSA signed prior to 1/1/19. That does not mean the divorce must be finalized by that date, but they must have completed and signed the PSA by that time. If the court is deciding the alimony matter as part of the divorce, however, then the actual divorce date is the relevant point in time.
In Northern Virginia, especially Fairfax County, there is a well-respected formula for setting the alimony amount:
- 28% of the higher income earner’s income minus 58% of the lower earner’s/non-
earner’s income for spouses with minor children;
- the formula is 30% minus 50% if there are no minor children.
However, be aware that the Fairfax county formula has the deductions/taxed baked in. So if you want to use the formula, you might want to consider tax affecting that number.
A good mediator will know how to do this.
FYI, CHILD SUPPORT IS NOT DEDUCTIBLE/TAXABLE:
Child support, on the other hand, is a tax desert. There is no tax benefit to the payer, and the recipient is not taxed on the child support received. This is because the lawmakers determined, many years ago, that parents should be supporting their children whether it is in the form of “child support” or simply “supporting your children”. Thus, there are no tax breaks for what the IRS believes you should be doing anyway.
FOR CASES THAT ARE GRANDFATHERED IN...
BE CAREFUL! The IRS has 2 important peculiarities with regard to classifying “alimony” payments from one spouse/former spouse to the other. These peculiarities are:
(1) The Alimony Recapture Rule; and
(2) The Child Contingency Rule.
THE ALIMONY RECAPTURE RULE:
Under §71 of the IRC, the IRS has the right to take back alimony deductions if there is a violation of the “Alimony Recapture Rule”. In other words, the IRS can make the payer spouse/former spouse go back and pay taxes on the dollar amount of alimony deducted from the payer spouse’s gross income if the IRS determines, under its Alimony Recapture Rule, that those payments were wrongly deducted. This can occur whether or not the payer (or his or her attorney) was aware of the Alimony Recapture rule or not. (Ignorance is not a defense.)
The Alimony Recapture Rule applies when spousal support payments are “front-loaded” during the first 3 years from the first date that alimony is paid. The purpose of the Alimony Recapture Rule is to discourage divorcing spouses from improperly classifying property settlement payments as alimony. In other words, the IRS is trying to prevent “sham” deductions.
ALIMONY RECAPTURE WORKSHEET:
For most people who are concerned about the Alimony Recapture Rule, the best way to determine whether or not there will be an Alimony Recapture situation during the first 3 years of paying spousal support is by using the “Recapture of Alimony” Worksheet provided by the IRS in Publication 504. It is reproduced below:
|1||Alimony paid in 2nd year||____________|
|2||Alimony paid in 3rd year||____________|
|4||Add lines 2 and 3||____________|
|5||Subtract line 4 from line 1||____________|
|6||Alimony paid in 1st year||____________|
|7||Adjusted alimony paid in 2nd year||____________|
|Line 1 less line 5:||____________|
|8||Alimony paid in 3rd year||____________|
|9||Add lines 7 and 8||____________|
|10||Divide line 9 by 2||____________|
|The number 2 (not line 2!):||____________|
|12||Add line 10 and 11||____________|
|13||Subtract line 12 from line 6||____________|
|Add lines 5 and 13:||____________|
The above calculation is actually factoring two computations, as follows, to determine if recapture is necessary. Almost no one can follow what the IRS is saying here... so most people just rely on the calculations. Here is the verbiage by the IRS:
(1) A taxpayer is subject to recapture of alimony payments made if, in the third post-separation (really, they should say, "post alimony payment") year, the alimony paid decreases by more than $15,000 from the second post-separation year. The excess over $15,000 is subject to recapture.
(2) A taxpayer is subject to recapture in the third year of making alimony payments if the payments made in the first post-separation year exceed the average of the payments in the second and third post-separation years by more than $15,000.
If both of these computations result in recapture, the amount recaptured under the first computation is subtracted from the second year payments for purposes of making the second computation.
THE CHILD CONTINGENCY RULE:
All deductions for alimony made are at risk of being taken back by the IRS if the cessation of those alimony payments are contingent upon any of the following child-related fact patterns:
(A) A child of the marriage obtaining a specified age, marrying, dying, leaving school or a similar contingency; or
(B) At a time which is clearly associated with a contingency of a kind specified in Paragraph (A), above (e.g. graduation from high school).
(26 U.S.C. 71(c)(2))
As clarified in the recent case of Johnson vs. Commissioner of the Internal Revenue Service (7th Circuit, 2014) (http://caselaw.findlaw.com/us-7th-circuit/1302834.html), even if the parties’ PSA clearly delineates which payments are for child support and which are for spousal support, the IRS still has the right to reclassify even agreed spousal support payments as child support if there is any contingency, involving a child, attached to that spousal support obligation.
If the IRS determines that a spousal support award was actually contingent upon a child-related event, it has the right to convert all payments made, from when the payer first commenced making spousal support payments to the recipient, into non-deductible child support.
Details about his fairly complex rule can be found by reading IRS Temporary Regulation 1.71-1T(c), Q&A 17 and 18 at:
PROFESSIONAL TAX SERVICES REQUIRED:
Nothing in this article is intended to substitute for professional tax or legal advice.
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