If you are divorced, in the process of divorcing, or having a prenuptial or post-nuptial agreement in place, the new tax law affects you.
You may have heard that there were changes made to the deductibility of alimony payments. Under the old rules, an individual who pays alimony can deduct the alimony paid from taxable income and those payments are then taxable income to the recipient spouse. Under the Tax Cuts and Jobs Act (TCJA) passed December 22, 2017, there is no longer a deduction for alimony for the payer, and alimony is no longer includable in the taxable income of the recipient. So, for divorces and legal separations that are executed (came into legal existence) after 12/31/2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse won’t include them in gross income or pay income tax on them.
The new TCJA rules don’t apply to existing divorce and separation agreements. The old rules continue to apply to agreements already existing before 01/01/2019. However, some taxpayers may want the new rules to apply to their existing agreement. Under a special provision, if taxpayers have an existing (pre-01/01/2019) agreement which is legally modified after 12/31/2018, the new rules can apply to that modified agreement if the modification explicitly provides for it.
There may be situations where voluntarily applying the TCJA rules is beneficial. A significant change in the income levels of the alimony payer or the alimony recipient could be enough reason to consider renegotiating existing divorce agreements. Another reason is that the loss of the full deduction for state and local taxes for a taxpayer in a high-tax state might have enough economic impact to create a hardship due to a substantial tax increase. Lastly, many agreements include provisions specifying which party will claim tax exemptions for their dependent children. Under the TCJA, these exemptions have been suspended until 2026. In the meantime, taxpayers who negotiated for the exemptions by giving up other items of value in the divorce settlement will find that this bargained-for benefit has evaporated.
The Tax Cuts and Jobs Act will have a significant impact on existing and future divorce agreements. If you would like to discuss the impact of these new tax rules on your particular situation, please give us a call.