06 February 2020

Change in US tax treatment of alimony and its impact on divorce negotiation


Since 1942, a US taxpayer who received alimony or separate maintenance was required to include it as taxable income unless the parties agreed that it would not be tax deductible for the payor. However, the 2017 Tax Cuts and Jobs Act (‘TCJA’) altered this long-standing rule. It no longer allows a deduction for the payment and simultaneously excludes the alimony from income. Essentially the new method results in a tax neutral transaction. This seems easier, right?

Perhaps in theory. The law applies to divorce or separation agreements executed on or after 1 January 2019 but it can also apply to any agreement executed before 1 January 2019, but which is subsequently modified after that date. The modification must expressly state that the TCJA’s amendments apply to the modified agreement. Any agreements that were executed prior to 1 January 2019 were grandfathered into the old rules.

So what’s the problem? Unfortunately, this may become a headache for those whom have entered into nuptial agreements prior to 1 January 2019 but later divorce. If the nuptial agreement imposed limits on alimony payments based on tax deductibility which is no longer available, there could be a dispute and possible litigation over the consequences of the change of rules. To avoid this issue, US tax sensitive couples should consider reviewing and potentially modifying their nuptial agreements.

Additionally, as there is no longer a tax benefit associated with the alimony payment, taxpayers may want to find different ways to provide support. Options include adjusting the amounts of alimony paid to reflect the change in economics in the nuptial agreement or making lump sum payments. Others may wish to transfer funds from their individual retirement accounts. According to the Joint Committee on Taxation, the change will raise revenue to the IRS by approximately $6.9 billion over the next decade. While the IRS’ pockets may grow fuller, many predict that overall alimony might decrease as different ways are used to make replacement provision.

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