As you may be aware, tax reform in 2018 eliminated the tax deduction that was available for those paying for alimony. This eliminated the tax break for the spouse paying the alimony, and thus may have a ripple effect for divorced spouses and families. According to the IRS, around 12 million tax returns claimed a deduction for paying alimony in 2015 and around 50% of the US population has marriages that end in divorce, so this can have major ramifications for parties involved.
Many divorce cases involve long-term marriages in which there is one spouse who earns more money than the other – typically a stay at home wife or mom to raise the children.
With the deductibility of alimony going away, it may make alimony less appealing and lower the amounts paid, which could ultimately hurt the divorcing spouse and children and family overall. Payers are less likely to pay alimony because they won’t get the tax deduction that previously had been available, and judges may perhaps take this into consideration and thus may order less alimony for the other spouse.
For example, if the ex-husband in a 40% tax bracket is ordered to pay $100,000 per year in alimony to his ex-wife, he previously would be able to deduct that amount from his taxable income, making his true cost only $60,000. If the ex-wife is in a 25% tax bracket and would pay tax on that $100,000 as income, but in a lower income bracket, meaning she would owe the IRS $25,000 and keep $75,000.
In this example, the husband is not be able to deduct the alimony, meaning it would cost him an extra $40,000. The wife gets the whole $100,000 to spend.
What may happen as a result of this, is the alimony-paying ex-husband may be reluctant to pay out as much as $100,000 because the net payout is much higher, while the receiving spouse would be negotiating to hold ground, making tense negotiations even worse and may lead to more lawsuits.
This may lead to alimony agreements being settled based on net payments as if prior tax deductibility was still in the equation. Based on the prior example, the husband in the 40% tax bracket and was paying $100,000 may soon start paying $60,000 instead which equals the same amount he was paying before net of tax.
This is certainly an issue to pay attention to for current and future divorce cases within family law.
Ben Offit, CFP®