The Tax Cuts and Jobs Act, recently approved into federal law, is bringing a major change to the divorce arena. Specifically, the issue of alimony (or “spousal maintenance” as it is called in Arizona) will be changing in terms of how it is counted for tax purposes.
The Old Spousal Maintenance Tax System
Historically, the general rule was that if you had to make a payment of spousal maintenance, you were able to deduct that for purposes of taxation. Similarly, if you were the party receiving spousal maintenance, you were required to count that as income for tax purposes.
In contrast, child support was not accounted for when calculating taxes. So the person making payments would effectively just be out the money (at least for tax purposes), while the person receiving it would receive the benefit of not being taxed on it.
Understanding this dynamic generally played a major role in negotiating spousal maintenance and child support settlements in divorce.
The New Spousal Maintenance Tax System
Under the Tax Cuts and Jobs Act, spousal maintenance will no longer be treated as a deduction to the person paying and income to the person receiving it. Instead, the Act makes it such that the party paying spousal maintenance gets no special tax benefit from it and the person receiving essentially gets the money tax free. The new law is set to go into effect on January 1, 2019.
Divorce orders for maintenance that went into effect before the new law’s effective date will still be subject to the old tax rules. Because of that, if you want to take the tax benefits of the old system, you must have your decree executed before December 31, 2018.
Another consideration is that some spousal maintenance orders will have gone into effect prior to January 1, 2019, but get modified after that date. If you are in that situation, then you will still reap the benefits of the old tax rule unless the modified order states that the new tax rule applies.
Potential Problems and Considerations Revolving Around Your Spousal Maintenance Obligation and Taxes
This fairly significant change means a whole different set of considerations when looking at a divorce. In a very general sense, if you are the person paying spousal maintenance, you want to get your divorce order signed before 2019. If you are the recipient, you want the exact opposite.
However, one consideration is that if you look at the couple’s income as a collective, by waiting until after 2018, you may be depleting the overall resources available to either party. For example, if the spouse paying maintenance is in a higher tax bracket than the person receiving maintenance, then you are preventing the money between the two parties from being taxed at the lower income earner’s tax rate and therefore take away more money available to both because the higher income earner’s tax rate will end up handing the IRS a lot more money. This argument could be raised as a reason that the recipient should receive less in spousal maintenance.
These issues are obviously complex, so we highly recommend that you speak with an accountant and/or a family law attorney if you are in the midst of a divorce with spousal maintenance at issue.