DO YOU KNOW HOW THE NEW TAX LAW EFFECTS YOUR CURRENT OR PAST DIVORCE SETTLEMENT?
The new tax law, Tax Cuts and Jobs Act (TCJA) significantly impact changes to the tax consequences of the payment of maintenance (formally known as alimony). Maintenance/Alimony are the payments that may be required by one spouse to pay for the support of an ex-spouse. There is now a statute or law that sets forth how maintenance/alimony should be calculated, not only for the amount to be paid but the duration or length of payment. However, the law does not provide for any adjustment or consideration for the new tax law that changes the taxable effect and consequence to the payor and the payee of maintenance.
Under the old law which applies to any divorce insturment, either a Stipulation of Settlement or a Separation Agreement or Divorce Decree, that was duly signed and executed on or before December 31, 2018, the payment of maintenance would be a tax deduction for the payor and taxable income to the payee. Caution, and Important Note: notwithstanding the forgoing, if an Agreement or Decree that would qualify under the old tax law, is modified or changed after December 31, 2018, then that change, or modification would bring that Divorce under the new tax law. Therefore, the existing tax deductions would be erased. It is unclear yet whether the modifications must concern maintenance only.
For individuals that are required to pay maintenance, the change in the tax law can be very expensive, since the tax savings that were previously available, permitting a deduction of maintenance payments, can be substantial.
As of January 1, 2019, maintenance payments are no longer tax deductible by the payor and recipients no longer have to include them as taxable income. This applies to all divorce Agreements that are executed after December 31, 2018. Important note, as previously mentioned, this also applies to any divorce Agreement that is modified after December 31, 2018. So, if your maintenance was tax deductible in your original Agreement and the Agreement is thereafter modified after December 31, 2018, you may no longer have the benefit of that tax deduction due to the modification of that Agreement. As a point of information, child support payments and the division or distribution of marital assets, known as Equitable Distribution, are treated as non-deductible personal expenses for the payor and tax-free payments for the recipient. Therefore, there is no tax consequence for either party, with respect to equitable distribution of marital assets or the transfer or receipt of a distribution of monies, property, etc., that were marital and now have been distributed between the two parties or the payment of child support for the support of children of the marriage.
Keep in mind, even if your Agreement qualifies under the old tax law, there are requirements to be met for maintenance to be tax deductible. So, first your Agreement must be either a written Divorce or Separation Agreement/Instrument or an actual Divorce Decree or Separation Decree that was executed and/or entered on or before December 31, 2018. Second, in order for maintenance to be tax deductible, it must meet the following requirements:
- The payments are made pursuant to a written Divorce or Separation Agreement.
- The payments must be made in cash or cash equivalent.
- Payments must be to or on behalf of your spouse or ex-spouse, not a third party. Therefore, payments to third parties, such as an attorney or mortgage lender are permitted if they are made on behalf of a spouse or ex-spouse and pursuant to a written Divorce or Separation Agreement, or a written request of the spouse or ex-spouse.
- The ex-spouses cannot live in the same household or file joint tax returns. If the ex-spouses are sharing or living in the same household or if they choose to file a joint tax return for tax benefits, then these events will disallow a tax deduction for the payment of maintenance.
- The payment cannot be child support. To preserve the deductible maintenance payment(s) cannot be classified as or deemed to be child support under the maintenance tax rules. What constitutes child support or what may be “deemed” child support and the rules regarding these classifications are complicated and can create a nasty trap for an uneducated tax payer. It is important to consult a tax professional when considering the tax ramifications of your existing or current Divorce Agreement with respect to the taxable impact of maintenance and when trying to sort out the rules regarding child support or what may be “deemed” child support in your Agreement
- No obligation for the payment of maintenance are to continue after the recipient’s death. In other words, your Agreement must provide that any obligation to make payments for maintenance (other than payments of delinquent amounts that may be due pursuant to the Agreement) must cease upon the payee or recipient’s death. If your Divorce Agreement or Divorce Decrees are unclear about whether or not the payments must continue, applicable state law controls. So, the payment obligations must cease in the event of the recipient’s death in order for the payments to qualify as tax deductible maintenance. This oversight is the most common reason for lost maintenance deductions.
Based upon the current law, maintenance can be extremely impactful, not only in the monetary amount to be paid but the duration, how long maintenance is paid. The duration of the marriage will determine the length of or how many years maintenance must be paid. So, for tax purposes, this is an incredibly significant financial loss with the eraser of this tax deduction. This will also impact how future divorce settlements are negotiated and implemented.
The new tax law makes significant changes not only to the deductibility of maintenance but personal injury law suit recoveries. For a personal injury law suit recovery, there is no longer a write off for legal fees or the cost of the personal injury law suit. The person receiving a significant Personal Injury award, will now be taxed on all of their award. This might not seem like a big issue, but when you consider it includes lawsuits related to various issues, such as privacy, deformation of character, divorce, child custody, wrongful imprisonment, malpractice, punitive damages and other common legal problems, the impact is likely to be much more widespread among tax payers.
These significant changes to the deductibility of these items can add up to significant liability on your tax return. Therefore, it is always important to make sure you discuss your personal legal situation and tax implications with a tax professional to make sure the decisions you make are tax prudent.