The Tax Cuts and Jobs Act, passed in December 2017, brought about a number of sweeping changes to existing tax law. While much of the immediate focus on the bill was related to changes to income tax rates and tax brackets, some of the substantial changes brought about by the Act will directly impact divorces. The new tax law for 2019 changes the way that spousal support payments are taxed for both the payer and recipient. At the present moment, these changes are still on the horizon. Because of this, individuals entering a divorce will need to weigh the benefits of finalizing a divorce before the new tax laws take effect.
How Are Spousal Support Payments Currently Taxed?
To understand how significant of a change the new law represents for individuals going through a divorce, it is first helpful to gain some insight into how spousal support payments are treated under current tax law. Under the current tax regime, the individual making a spousal support payment is able to deduct that payment from his or her taxable income for tax purposes as an “above-the-line” standard deduction.
The difference between an “above-the-line” tax deduction versus a “below-the-line” tax deduction is key to understanding how spousal support payments are taxed under the old tax law. First, understand that “the line” referred to in both of these phrases is an individual’s adjusted gross income. A spousal support tax deduction made “below-the-line” is made after the adjusted gross income has been calculated. In contrast, “above-the-line” deductions are made before calculating your adjusted gross income. Put another way, an “above-the-line” deduction reduces your adjusted gross income. This can have a range of benefits for individuals when in the preparation of taxes, and was a significant tax advantage for individuals making spousal support payments.
While individuals making spousal support payments could reap the benefits of claiming their payments over the course of the year as an “above-the-line” deduction, reducing their taxable income, individuals receiving spousal support payments were required to pay taxes on any amount received. Under the old law, the recipient was required to report spousal support and pay income on the amount received just like any other income source.
Taken together, the ways that spousal support payments were taxed before the Tax Cuts and Jobs Act shifted the tax burden to the recipient of the funds. The individual making spousal support payments was able to use the full support amount to reduce adjusted gross income, which itself can bring a range of other tax benefits. The individual receiving spousal support payments was required to report the amount of money received for the year on his or her tax return as income. This required spousal support recipients to pay taxes on all money received, similar to other income sources.
What Exactly Changed?
The new tax law for 2019 fundamentally changed the way that spousal support payments are taxed. The new law affects both the payer and recipient differently, so it is worthwhile to examine the impacts on both.
For individuals making spousal support payments, the new tax laws for 2019 are less advantageous. Individuals making spousal support payments to an ex-spouse will no longer be able to take a deduction for the amount paid. This means that money paid out in spousal support will still count toward that individual’s taxable income. The individual will, therefore, have to pay taxes on that money. While the requirement to pay taxes on the money is a disadvantage, in some instances the reduction to the individual’s adjusted gross income under the old tax regime brought substantial advantages when filing at the end of the year. Not being able to deduct spousal support paid as an “above-the-line” deduction, reducing an individual’s adjusted gross income, may have a much larger impact than the actual amount of taxes paid on spousal support under the new regime for some individuals.
Under the coming tax changes, recipients of spousal support will no longer be required to pay taxes on any support received. The tax burden associated with spousal support has now been shifted to the individual making the payment. Eliminating the requirement to pay taxes on spousal support received will likely simplify the tax filing process for many recipients of spousal support payments. Money received through spousal support will no longer be added to adjusted gross income, which may bring other benefits such as reducing the overall tax burden.
When Do The Changes Take Effect?
The changes brought about by the Tax Cuts and Jobs Act are slated to take effect for all divorces finalized after December 31, 2018. Divorces that are finalized on or before December 31st of this year will be grandfathered into the old tax law. It is important to note that support provisions for individuals who are already divorced will continue to remain under the provisions of the old tax law. This means that spousal support will continue to be taxed the same way. Additionally, modifications can occur to the terms of an existing divorce or separation judgment without bringing it under the new tax law. In some cases, individuals may wish to have the new tax law apply to their divorce or separation agreement, which can be arranged by virtue of a modification to the settlement agreement.
The Tax Cuts and Jobs Act brought about substantial changes to the way that spousal support payments are taxed. Under current tax law, individuals making spousal support payments were able to deduct the amount of support they paid “above-the-line”, reducing adjusted gross income. Recipients of spousal support payments were required to report spousal support received as income and pay taxes on those funds. Under the new tax law for 2019, the tax burden has been reversed. Starting in 2019, individuals making spousal support payments will no longer be able to deduct the payments from taxable income, requiring them to pay taxes on the amount they pay to an ex-spouse. In contrast, the recipient will no longer be required to pay taxes on any support received.
The good news is, if you still wish to have your spousal support agreement fall under the older tax law, there is still time. Divorces or separations finalized before December 31st, 2018 will be grandfathered into the current application of tax law to spousal support payments.
In order to determine if finalizing your divorce or separation before the new law goes into effect is advantageous for your situation, get in contact with the experienced Family Law attorneys at Bremer Whyte Brown & O’Meara today.