Posted on February 19, 2018 by Lasher Holzapfel Sperry & Ebberson
In a divorce, there are generally three types of payments that can be made between the divorcing parties. The first is considered an equalizing property transfer payment. For example, if, after the allocation of all real property, bank accounts, retirement accounts, and investment accounts, there is a disparate value between the parties, one party usually pays the other party a sum of money to achieve the desired division of all assets. This is considered a property transfer payment is not subject to federal income tax as long as it is qualified as a property transfer payment pursuant to Section 1041 of the Internal Revenue Code.
The second payment type is child support. This is usually in the form of a monthly payment, usually to the person who can claim the children as a dependent. This payment does not get reported as taxable income to the receiving party nor does that paying party receive a tax deduction.
The third type of payment is maintenance, or spousal alimony. This is separate from child support and is also usually a monthly payment from one party to the other over a period of time. These funds have long been considered a tax-deductible expense to the person paying maintenance and must be reported as taxable income for the person receiving maintenance.
The deductibility of maintenance can be a useful tool in negotiating a divorce, since it can significantly shift the relative tax liabilities of the parties. For example, you have a situation where the Wife is in the 28% tax bracket and the Husband is in the 15% tax bracket. The Wife is required to pay the Husband $20,000 per year for maintenance. For purposes of federal income taxes, therefore the parties could effectively shift that $20,000 to a lower tax bracket, which was a key element of negotiating the division of assets and obligations.
However, under the under the Bipartisan Budget Act of 2015 (November 2, 2015), this deduction is no longer available. For any divorce finalized after December 31, 2018, the payment of maintenance will no longer receive this special tax treatment. The paying spouse will not receive any tax deduction and the receiving spouse will not have to pay taxes on the maintenance received. Therefore, in the above example, the Wife will pay $20,000 per year and the Husband will receive the same $20,000. The Wife will pay full taxes on the $20,000 at her tax rate.
For parties currently in the middle of a divorce, this may cause some confusion and will undoubtedly change the entire landscape of divorce negotiation. When negotiating potential settlements, the parties must consider whether they will be able to finalize the divorce by the end of the year. If not, it is likely that the specific amount of maintenance will need to be re-negotiated.
The change in the tax law upends a long-standing tax approach and approach to maintenance payments. All parties in the dissolution field will now have to figure out a new approach and calculation methods for determining an equitable maintenance payment.
It is also important to note that for all divorce decree entered prior to December 31, 2018, the tax deduction for maintenance remains in place. If you have a previously entered decree and are currently paying maintenance, you can continue to take the tax deduction. If you are currently receiving maintenance, you must continue to pay taxes on the funds received. How the IRS will determine which tax returns should be reporting maintenance under the old law and which under the new law, is yet to be determined. It may be necessary to provide a copy of your divorce decree with your tax return.
If you are going through a divorce now or are considering a divorce in the future, it is vital to consult with a divorce attorney and tax attorney to determine how these changes in the law may affect your finances. Please contact Miriam Gordon at Lasher Holzapfel Sperry & Ebberson PLLC to set up a consultation to discuss your specific situation.