In divorce situations, an ex-spouse may be legally obligated to make payments to the other party. Since payments are often substantial, locking in tax deductions for the payer has often been important and involved a substantial amount of money.
Before the Tax Cuts and Jobs Act (TCJA) was enacted, payments that met the tax-law definition of alimony could always be deducted by the payer for federal income tax purposes. The recipient had to report the money as taxable income.
This treatment continues under the new law for alimony payments made under divorce agreements reached before 2019. But for payments made under agreements after 2018, things will change dramatically. Here’s what you need to know.
Alimony Deductions After 2018
For payments required under divorce or separation instruments reached after December 31, 2018, the tax deduction for alimony payments is eliminated. Alimony recipients will no longer include the payments in taxable income. For high-income individuals this can be an expensive change — because the tax savings from deducting alimony payments can be significant.
This new treatment of alimony also will apply to payments under divorce or separation instruments that are modified after December 31, 2018, if the modification specifically states that the new TCJA treatment applies.
Before 2019 — Business as Usual
For pre-2019 alimony payments to be tax-deductible, payers must satisfy a list of specific requirements. If those requirements are met, alimony payments can be written off “above-the-line” on the payer’s federal income tax return. In other words, the payer doesn’t have to itemize to benefit.
When payments fail to meet the tax-law definition of alimony, they’re generally treated as either child support payments or payments to divide the marital property. Such payments represent nondeductible personal expenses for the payer and tax-free income for the recipient.
Requirements for Deductible Alimony
Whether payments qualify as tax-deductible alimony or not is determined by strictly applying the requirements listed in the Internal Revenue Code and related regulations. In general, what the divorce decree might say and what the divorcing couple might intend doesn’t matter. For a particular payment to qualify as deductible alimony for federal income tax purposes, it must meet the following eight requirements:
1. The payment must be made under a written decree of divorce, separate maintenance or separation.
2. The payment must be to, or on behalf of a spouse of, a spouse or ex-spouse. Payments to third parties, such as attorneys and mortgage lenders, are permitted if they’re made under the divorce or separation agreement or at the written request of the spouse or ex-spouse.
3. The divorce or separation instrument can’t state or effectively stipulate that the payment isn’t alimony because it isn’t deductible by the payer or won’t be included in the payee’s gross income.
4. After the divorce or legal separation, the ex-spouses can’t live in the same household or file a joint tax return.
5. Payments must be made in cash or cash equivalent.
6. Payments can’t be classified as fixed or deemed child support. The rules regarding what constitutes child support — especially what constitutes deemed child support — for this purpose are complicated and represent a nasty trap for unwary taxpayers. Contact your tax professional if your proposed divorce agreement includes payments meant to be alimony or child support.
7. The payer’s tax return must include the payee’s Social Security number.
8. The obligation to make payments (other than payment of delinquent amounts) must cease if the recipient dies. State law controls if the divorce papers are unclear about whether or not payments must continue (to the estate and eventually to beneficiaries of the estate). If under state law, the payer must continue to make payments after the recipient’s death, the payments can’t be alimony. Failing to meet this requirement is probably the most common reason for lost alimony deductions.
Timing Is Everything
If you’re in divorce proceedings and want deductible alimony treatment for some or all of your alimony payments, the TCJA gives you a huge incentive to get your divorce agreement signed, sealed, and delivered by December 31, 2018.
On the other hand, if you will receive alimony, you have a big incentive to put off finalizing your agreement until next year.
Either way, you should contact your PDR tax advisor as soon as possible to get the best tax results for yourself. Waiting too long could turn out to be an expensive tax mistake you may have to live with for years.