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Personal Finance

You Can Probably Still Deduct Your Alimony Payment

A tax deduction for the payer is no longer allowed, but the new tax laws may not apply to you.

Note: For more about financial planning and divorce, see our recent report by behavioral scientist Sarah Newcomb, The Big Split: Minimizing Conflict in Divorce Financial Planning.

Q: Can I still deduct my alimony payments?

A: The Tax Cuts and Jobs Act did change the way alimony is taxed. However, if your alimony payment is part of a divorce settlement that was reached before Dec. 31, 2018, the new tax laws more than likely do not affect you and you can still deduct your alimony payments as an above-the-line deduction.

What Is Alimony? Alimony, or spousal support, is intended to mitigate the effects of divorce on the lower-earning spouse. The periodic payments help the lower-earning party maintain the same standard of living he or she was accustomed to when in the marriage. Also, alimony payments are part of a divorce settlement and do not include voluntary payments or payments to keep up property, according to IRS publication 504. The payments can be temporary or transitional or more permanent in nature, depending on the agreement.

Alimony is not the same as child support. The tax laws relating to child support payments are not changing: The payer cannot deduct the payments and therefore they are not taxable to the recipient.

What's Changing? The way it has worked (for decades) is this: The former spouse paying the alimony can deduct it from gross income to calculate his or her adjusted gross income. (Instead of being on Page 1 of form 1040 as it has been been in the past, however, above-the-line deductions are now on a separate form called Schedule 1.) The recipient then pays taxes on the alimony received.

If you were divorced before Dec. 31, 2018, nothing is changing for you regarding the way your alimony payments are taxed this year or in future years (unless you opt to change the tax treatment of your existing divorce settlement).

However, if your divorce settlement was negotiated in the past several weeks (or you've opted to adopt the new tax treatment), alimony is paid with aftertax dollars, and the recipient does not pay taxes on it.

Why? In general, shifting the tax burden to the payer will lead to more money being paid in taxes overall. (The Joint Committee on Taxation estimates the change will raise $6.9 billion over 10 years.) The reason is that, presumably, the higher-income spouse is the one paying the alimony, and the higher-income spouse is likely in a higher tax bracket. (If you and you former spouse are in the same tax bracket, your alimony payment is probably not as significant.)

Here's an example. Let's say $1,000 a month is paid to a former spouse by a higher earning ex. If the payer is in the 32% tax bracket, he or she can save $3,840 in taxes by deducting the $12,000 paid. The recipient--let's say he or she is in the 22% tax bracket--then pays $2,640 in taxes on the $12,000.

Under the new rules, however, the higher earning spouse pays the full $3,840 in taxes. So the former spouses will pay $1,200 more in taxes on $12,000 under the new rules ($3,840 - $2,640 = $1,200).

How Will the New Laws Affect the Payer? This change will increase the alimony payer's taxable income, which could push him or her into a higher tax bracket. It could also affect the payer's eligibility for other credits and deductions.

If the person paying the alimony is a custodial parent, the new law could also result in less financial aid being available to prospective students applying for aid using the Free Application for Federal Student Aid. (The form uses prior-prior-year tax returns, so this would only apply to students whose parents were divorced in 2019 or later, seeking aid for the 2021-22 school year.)

How Will the New Laws Affect the Recipient? The biggest potential downside for the recipient in my opinion is that the alimony payer's tax deduction has been in place for decades, and was likely taken into account when determining how much alimony the payer can afford to pay. Some divorce experts theorize that eliminating the payer's deduction could result in a lower alimony payments in many future divorce settlements, because more of the available money will be going to taxes.

Another potential downside to the recipient is that taxable alimony was considered qualifying income for making an IRA contribution, and likely will not be under the new laws (though I have yet to see an IRS ruling on this topic).

A potential benefit, though, is that because the alimony will no longer be considered taxable income, the recipient may be eligible for more tax credits that phase out at certain adjusted gross income thresholds. For example, it will be easier for the alimony recipient to qualify for the newly expanded, partially refundable $2,000 child credit and/or the $500 dependent who is not a qualifying child. (Eligibility for that is based on adjusted gross income.)

Another potential benefit is that if the recipient is a custodial parent, a prospective student might also be able to qualify for more financial aid as well as the American Opportunity Tax Credit or the Lifetime Learning Credit.

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