by Chris Chen, CFP, CDFA
“Eliminating the deductibility of alimony payments from taxable income is one of the features of the Republican House Tax Reform bill. It is very significant to both payors and recipients of alimony. Currently, payors can deduct their alimony payments from their taxable income. As a result, they reduce their taxable income and their income taxes. On the other hand, recipients include alimony in their taxable income. In general, there is a difference in the tax brackets of the two (recipients usually have a lower tax bracket than payors). As a result, divorcing couples can often save money on income taxes by placing the tax burden on lower earners. With that saving, they may be able to better afford the expenses of divorce.
Eliminating the alimony deduction will not generate a lot of tax revenues. According to the House, the provision will only raise about $8 billion over 10 years. While the bill increases taxes on alimony payors it also decreases taxes on recipients. For recipients, alimony income would no longer be taxable.
This change in taxes should have a strong impact on divorce agreements. For many payors, saving on income taxes on alimony payments is the saving grace that comes with making alimony payments. According to John Fiske a prominent family lawyer and mediator in the Boston area, “alimony is the greatest tax deduction ever”. Without the tax deduction, alimony payors will find it much more expensive and more difficult to agree to pay.
For instance, alimony payors in Massachusetts often pay between 30% and 35% of the difference in the spouses’ income. For a payor in the 33% federal tax bracket, the House Tax Reform bill increases the cost of alimony by nearly 50%.
State laws, guidelines and practices around alimony are largely based on payors’ ability to deduct it. Should the alimony provision of the House Republican Tax Reform survive, it may well lead to a race in the states to amend alimony laws to decrease alimony payments. Even though recipients would no longer include alimony in taxable income, it is likely to reduce their income even more. As a result pre and post-divorce financial planning that helps both parties to recover financially from divorce is more important than ever.”
A complete version of this blog may be found at Insight Financial Strategists A version of this post also appeared in Kiplinger.com.