TCJA and Alimony

By now we all familiar with the direct change the law known as the Tax Cuts and Jobs Act (TCJA), P.L.115-97, made to divorce planning with the elimination of deductible alimony payments for the payer spouse and inclusion of income for the receiving spouse. This change has substantially altered the divorce planning landscape. 

This new rule applies to any divorce or separation instrument (as defined in IRC Sec. 71(b)(2)) executed after Dec. 31, 2018, or for any divorce or separation instrument executed on or before Dec. 31, 2018, and modified after that date, if the modification expressly provides that the TCJA amendments apply. This may open up a planning opportunity for divorced taxpayers!

Typically when divorce settlements are drafted, the payment of federal and state income taxes are contemplated. The payer spouse will benefit from a tax deduction and the receiving spouse has to pay income taxes. In some cases the payer spouse may even “gross up” the receiving spouse to take into consideration income taxes that are required.

Let’s consider the situation wherein a couple got divorced five years ago. Part of their settlement agreement included alimony payments. Let’s also say the wife grosses up the payment so the husband gets an after-tax amount, which essentially means she is paying the taxes for him. The Wife was a successful business owner and had substantial earnings from her business. The husband had minimal income outside of the alimony.  While the business was operating successfully, the wife fully benefited from the alimony deduction.  The husband paid income taxes on the alimony.

Now, five years later, the business is sold and the wife only has investment income and/or retirement income.  After taking into consideration itemized deductions, the wife may benefit for only a portion, or none, of the alimony deduction but the husband will still pay tax on the full amount -- not a great outcome.

Based on the new law, the couple can modify their agreement to expressly state that the alimony or separate maintenance payments are not deductible by the payer spouse or includable in the income of the receiving spouse.  By doing this, it is possible to avoid the situation whereas there is a mismatch of no deduction for one spouse and full taxation for the other spouse.

Additionally, if state law will allow, the couple may also consider modifying the amount of the alimony payment taking into consideration the receiving spouse does not have to pay income taxes.