March 18th, 2019
Breaking up is hard to do. Many times, when a marriage comes to an end and divorce proceedings begin, the business of dividing a couple’s finances can be frustrating even in the most amicable situations. As a result of the Tax Cuts and Jobs Act of 2017, any divorce agreement signed after December 31, 2018 will be subject to some significant changes in tax obligations which could have serious impact on settlements.
Prior to 2019, alimony had been deductible for the payer and taxable as income for the recipient. That has now been changed. Under the new tax law, alimony is no longer a deduction for the payer and is no longer taxable to the recipient. This is a major change which will likely affect the way attorneys negotiate on behalf of their clients. Existing agreements are grandfathered under the old law.
Let’s review an example:
Joe is paying alimony. He is in the top 37% Federal bracket + 12% New York State/City bracket = 49% combined Tax Bracket. His ex-spouse Deb is in the 22% Federal bracket + 6% New York State/City bracket = 28% combined Tax Bracket.
If alimony is $100,000 and the divorce agreement was signed prior to 2019, the $100,000 would not be taxed by Joe, but instead taxed by Deb. ($100,000 * 28% (taxes) = $28,000 of estimated income taxes to be paid by Deb.)
If the divorce agreement was signed after 2018 the $100,000 would be taxed by Joe. ($100,000 * 49% (taxes) = $49,000 of estimated income taxes to be paid by Joe.)
Given this example, under the new amendments in the tax law, there would be $21,000 ($49,000 - $28,000) of additional taxes paid and this $21,000 is not available for either Joe or Deb!
What does this mean going forward?
- Both parties engaged in divorce proceedings should negotiate cautiously as this new shifting of the tax burden will greatly affect both the higher and lower-income spouse.
- People who are already divorced will be grandfathered in and the tax status of their alimony will not be changed provided that their agreements are not modified in, or after, 2019. If an agreement is modified, the new agreement must state which tax treatment is being used.
- Pre- and post-nuptial agreements should be reviewed by an attorney to see if any changes are recommended in light of this new law.
Additional Tax Law Changes
- Elimination of Dependent Exemptions - the previous $4,050 exemption for each dependent has been eliminated through 2025.
- Child Tax Credits - the child tax credit has doubled from $1,000 to $2,000, with certain criteria.
- Standard & Itemized Deductions changes – the standard deduction amount has increased while certain itemized deductions have been eliminated or changed.
- New Federal Tax Brackets = The new federal brackets are now 10%, 12%, 22%, 24%, 32%, 35% & 37%
A full understanding of how these changes will impact your taxes and cashflow is very important when negotiating a divorce settlement.
As the previous tax laws regarding alimony had been in place since 1942, these major changes will likely result in a learning curve for attorneys as they adapt to the updated tax code and the ramifications it will have overall on financial settlements. It could be helpful to consult with a financial advisor to better understand your specific situation and the tax obligations associated with various alternatives in a divorce agreement.