If you're involved in a divorce, a new year will usher in a different sort of tax wrinkle.
Sweeping changes to the U.S. tax code passed by Congress in late 2017 include eliminating the deduction for alimony payments. But removal of a spousal support federal tax write-off as mandated by the Tax Cuts & Jobs Act doesn't kick-in until 2019.
Technically, the TCJA stipulates that elimination of deductions for alimony payments under divorce or separation agreements will go away for cases executed after Dec. 31, 2018.
That's causing many attorneys to stress more advanced financial planning to couples going through divorce. And their reasoning is simple: such a so-called maintenance tax cuts two ways.
Typically, the higher-earner gets to take advantage of alimony deductions. As certified public accountant and head of IFA Taxes John Dahlin points out, parties on the other side -- those who receive alimony payments -- are required in most cases to report such activities as income on their tax forms.
"The tax overhaul reverses that arrangement, denying the tax deduction to alimony payers while making alimony tax-free to those who receive it," notes Bloomberg in a recent report.
Modifications to deals struck after that date should also be carefully reviewed to ensure inclusion of the TCJA's new treatment of alimony payments, legal experts caution.
"Simply stated, the spouse paying alimony cannot deduct it, and the spouse receiving the money no longer is to pay taxes on it. This is the exact opposite of the current law that has been in effect for 75 years," observes Tom Leustek of New Jersey Alimony Reform in a study of the impact of the TCJA on divorcing couples.
Part of his research takes a look at a hypothetical situation where a higher-income earner who in the past has paid and deducted $30,000 a year in alimony. Since his/her federal income is taxed at 33%, such a deduction saved him/her $9,900 a year.
Meanwhile, the other ex-spouse in this made-up scenario -- who is taxed on the federal level at 15% -- pays $4,500 a year under their divorce agreement.
"The arbitrage created by the difference in tax rates has long served as a benefit to the spouse paying the alimony and has been a factor both in negotiating matrimonial settlements and in bridging the gap between the parties’ needs and their actual income," the research paper summarizes.
It adds that if "alimony is no longer deductible, the ability of an ex-spouse to pay it will be limited by the need to pay other necessary fixed expenses such as child support payments and education expenses for children."
One strategy to offset loss of alimony deductions under the TCJA might be to consider greater use of individual retirement accounts. As tax-friendly investment vehicles, IRAs can turn out to be a workable alternative to simply swapping cash or expensive assets like properties, cars and boats to help mitigate overall tax obligations.
Each situation is different, however. At IFA Taxes, we find that trying to apply generic tax strategies to specific individual circumstances isn't usually a wise way to maximize tax savings and minimize liabilities.
For those moving into their next phase of life after a legal separation, these first major changes in generations to longstanding tax policies is raising a whole new set of financial questions.
At IFA Taxes, we stand ready to lend a helping hand. Our staff can act as trusted contributors to your existing team of lawyers and financial advisors to provide another objective and expert set of eyes.
We can also help to guide a discussion about possible divorce-related issues as part of an ongoing consultation in helping to prepare your taxes throughout each year.