Because the taxation of alimony is about to change, it may make sense to finalize your divorce before the end of 2018
New alimony tax rules, included in the Tax Cuts and Jobs Act, apply to divorce or separation agreements executed after Dec. 31, 2018.
Because the changes can dramatically affect finances, experts say the new rules intensify the divorce process.
They also raise the specter that at least one soon-to-be-ex-spouse could take a big financial hit.
New rules coming
Starting Jan. 1, alimony payers will no longer be able to deduct this outlay from their federal income tax. That means many will want to lock in alimony terms this year. That way, they will be grandfathered into existing rules, allowing them to deduct alimony this year and in the future.
In addition, alimony recipients will no longer owe federal tax on this support. Many may insist on waiting until next year to finalize divorce terms, believing that will benefit them financially.
However, the overall net impact may hurt them financially rather than benefit them. Many experts recommend that couples settle cases this year, before the changes go into effect.
Involving a knowledgeable financial advisor with experience in the financial aspects of divorce is the key to a fair resolution.
Divorce: How to Finalize
A recent survey of members of the American Academy of Matrimonial Lawyers found 95% of respondents expect the new alimony rules will change how divorces are settled.
And 64% expect the change will make divorces more acrimonious.
The law change has the potential to cost a lot of people big bucks.
In the 2015 tax year — the latest year for which the IRS has data — 598,888 taxpayers claimed the alimony deduction (on Form 1040). Their deductions totaled more than $12.3 billion.
Ginita Wall, director of Women’s Institute for Financial Education (WIFE) suggests, that anxiety has been rising this year among prospective alimony payers (typically men) and recipients (usually women).
In divorce workshops. “it’s become more of a life-or-death issue, for both men and women,” says Wall,
For alimony payers, getting the tax deduction is very important.
The deduction dampens the financial impact of alimony on payers. The new rules removing it could hit payers three ways.
Not only will they lose the deduction, but without it some may be pushed into a higher tax bracket. Plus, they’ll still have to pay the spousal support with fewer available dollars.
For those reasons, many alimony payers should consider settling a divorce before the end of this year.
Doing so will allow them to deduct alimony in future years using existing rules rather than the new rules.
Alimony recipients have the opposite incentive. On the surface, many of them will be motivated to wait until next year.
They will no longer owe federal income tax on alimony.
However, because payors will have more reasons to lower payments in settlements after this year, recipients may not come out ahead financially by delaying the divorce.
The size of any cuts in payments could exceed the savings from no longer owing alimony tax,
Many recipients would be in a low tax bracket due to other changes in the Tax Cuts and Jobs Act.
Here’s the bottom line:
In many cases, the alimony tax change will actually hurt women more than men.
How it works
Let’s say the court decides that the husband will pay spousal support of $3,000 per month for 10 years. We’ll assume he is in a high tax bracket and his combined marginal federal and state income rate is 43%.
Let’s also assume the wife is in a much lower combined rate of 18%. In this case, the net cost of the $3,000 to the husband is $1,710 and the net amount received by the wife is $2,460.
That’s quite a difference that will disappear at the end of 2018.
Ways to reduce conflict
- Act now. Both parties should strive to get a divorce settled this year. If the divorce isn’t executed this year, the new alimony tax laws will apply, and negotiations may have to start from square one. If that happens, attorneys’ fees and other costs of the divorce would likely rise. And it may be difficult to predict which spouse will most benefit financially.
- Seek help. Divorcing couples should work out their finances together. But if anger and other emotions prevent this, they should seek help from an intermediary, such as a Certified Divorce Financial Analyst, to avoid slowing down the divorce process. Mediators can also help couples bridge their differences.
- Consider asset trades. If alimony is a sticking point, payers could consider offering an asset transfer, such as a lump sum payment, as an alternative to alimony. Among the attractions of this option: The value of asset transfer is not taxable to either party in the divorce. However, this option applies only to those who can afford a large up-front payment.
- Use appropriate tools. Calculators are available online to help roughly gauge how much alimony could be expected or awarded in a particular state. But be cautious; most alimony calculators haven’t yet been adjusted to account for the coming tax law change.
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