How the New Federal Tax Law Affects Alimony for Californians
The Tax Cuts and Jobs Act of 2017 (TCJA) went into effect on January 1, 2019. Because the act changes the ways in which alimony payments are taxed, those whose divorces are finalized in 2019 or later will be affected by the law. The IRS hasn’t issued formal regulations yet to provide us with more information on the applicability of the TCJA in different scenarios. This blog sets out our current understanding of and analysis of the applicability of the TCJA in different scenarios.
Before 2019, if you paid alimony, you could deduct those payments and your spouse had to pay tax on them. This arrangement benefitted both parties in a divorce because the higher-income earner — the alimony payer — got the deduction, and the recipient paid income taxes at a lower tax bracket. Under the TCJA, alimony is no longer tax deductible, and recipients no longer owe income tax on alimony received. The deduction for high-earning alimony payers was a sizeable tax break and softened the blow on payments; without it, for alimony awards ordered from 2019 on, payers will pay more out of pocket, and recipients may wind up getting less.
Under the previous law, the deduction could save top earners up to almost 50 percent in taxes in high-tax states such as California. Consider a payer who owes a former spouse $10,000 in alimony annually. The payer’s deduction results in $5,000 in tax savings, meaning the payer’s out-of-pocket alimony expense is $5,000. Meanwhile, the recipient spouse would receive the $10,000 in payments and pay $2,000 in taxes, netting $8,000. The difference between the $5,000 that the payer spent and the $8,000 the recipient took home was known as the divorce subsidy —in this example, $3,000 in savings to the “family.”
But under the TCJA, with no tax break, the same paying spouse will have to fund the entire $10,000. The loss of the deduction as a negotiating tool may mean that high-earners will claim that they can no longer pay the original support amount. And for good reason: without the tax deduction, they may be stuck in a higher tax bracket, meaning they lose both the break on alimony (the $5,000) and will have to pay higher taxes on the rest of their income. Because of this new burden on the paying spouse, alimony recipients are likely to receive less than they would have under the old law, in amounts that far outweigh what they will save by not having to pay tax on the payments they get.
For those whose support order was issued in or before 2018, alimony payments are still deductible for the paying spouse and are considered taxable income for the recipient spouse. Although we do not have regulations yet on orders that are modified post-2018, the TCJA also seems to say that if modifications are made to spousal support orders in 2019 or later, the new law applies only if the parties specify in the revised stipulation and/or order that it should.
If you have questions about your spousal support arrangement or are contemplating divorce, Williams Family Law can help. Our firm represents clients in divorce, child custody, alimony and other family law matters throughout the Sacramento area. Call 916-407-0544 or contact us online to schedule a meeting.