The tax reform legislation passed in late 2017 provides the most sweeping changes in the tax code in years. While there are a number of changes that will impact many of us in various ways, the changes in the tax treatment of alimony payments could have a profound impact on couples contemplating divorce.
Divorce is an emotional issue that can have a significant and lasting impact on the couple involved and their families. Divorce is also a significant financial event as well.
Under the current tax rules, alimony payments are a deductible expense by the ex-spouse making the payments. Generally, alimony payments are made by the ex-spouse with the higher income. The current rules shift the tax burden of these payments to the ex-spouse receiving the payments, who is often in a lower tax bracket.
The new rules that go into effect for divorces that are finalized after 2018 eliminates the tax deduction for alimony payments.
Under the current rules here’s how the alimony deduction would work at the federal level.
Income of ex-spouse paying alimony $500,000
Federal tax bracket 35%
Annual alimony payment $100,000
Tax deduction $35,000
After-tax cost of alimony $65,000
Without the tax deduction the after-tax cost of the alimony increases to the full $100,000.
These changes could result in lower alimony payments going forward. The attorney for the alimony-paying ex-spouse could argue that the amount of alimony their client can now afford to pay will be reduced due to the loss of the tax deduction. If the argument is successful in reducing the amount of alimony, the ex-spouse receiving the payments will suffer financially on an ongoing basis as a result.
In a recent study, the Pew Research Center found that the rate of divorce among couples 50 and older more than doubled from 1990-2015. Many in this demographic are in high tax brackets and this change comes at a bad time for this group as they head into retirement. This is especially true if one spouse, often the wife in this age group, has been out of the workforce for a number of years raising children and/or serving as a caregiver to older family members.
Focus on divorce financial planning
This change due to tax reform doesn’t change the fact that divorce is a major financial event that requires careful financial planning during the process by both spouses.
It is important the couple seek sound, unbiased financial guidance from a fee-only financial advisor to ensure that a settlement that is as fair and equitable for both spouses is reached. Moreover, decisions need to be made with as little emotion as possible. For example, keeping the family home may be a poor financial choice if the costs of ownership will be a strain on the ex-spouse receiving this asset. It is important that all marital assets be considered as part of this process.
For couples nearer to retirement it’s important to understand the rules governing Social Security benefits from ex-spouses. These rules remain intact and both spouses need to incorporate them in their retirement planning.
Overall the loss of this tax deduction is an incentive for couples looking to divorce to get things finalized in 2018 if possible. Delaying things until 2019 or beyond might result in a lower alimony payment and will result in less money for one or both ex-spouses. Pre-divorce financial planning remains a critical part of the divorce process.
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Originally posted at https://thechicagofinancialplanner.com/tax-reform-and-divorce/