On December 22nd, 2017, The Tax Cuts and Jobs Act of 2017 (TCJA) was signed into effect, significantly changing the landscape of alimony payments. Because of this law, after January 1st, 2019, all alimony payments are not deductible and not taxable income to the recipient. But how does this affect each party involved in a divorce?
Our CEO and Senior Wealth Advisor, Marianela Collado, CPA/PFS, CFP®, CDS®, shared her insights with the Florida Academy of Collaborative Professionals (FACP):
“On the surface there is no apparent difference because, prior to TCJA, the alimony payment would have also been taxable to the recipient. But many times, the recipient of alimony has few or no other sources of income. That means they are likely to be in a lower tax bracket than the payor. In other words, the recipient would not pay the same $44,000 or $69,000 tax that the payor would have saved by deducting alimony.”
With the removal of the deduction, the cost of alimony now comes entirely from the payor’s after-tax income. Under the old law, a payor making a $120,000 annual alimony payment might have experienced an after-tax cost that was significantly lower, depending on their tax bracket. Today, that same payment is paid from post-tax dollars, which can reduce the payor’s capacity to support higher payment amounts.
Recipients, on the other hand, are no longer taxed on alimony received. However, because alimony payments are influenced in part by the payor’s ability to pay, the loss of the deduction may make larger awards more difficult to negotiate. While recipients benefit from tax-free income, the overall structure of support agreements may need to be reconsidered.
As a potential solution, the payor can create an alimony trust, which holds assets intended to provide income to the recipient. While contributions to such a trust are not deductible, it can be structured so that income paid from the trust is taxable to the recipient rather than the payor. This approach can help provide reliable income to the recipient, reduce dependence on the payor’s future earnings or life circumstances, and offer long-term financial security.
The TCJA has increased the financial complexity of alimony arrangements. While it has changed the tax dynamics for both parties, options like alimony trusts, when evaluated carefully, can offer thoughtful alternatives. A collaborative divorce process and guidance from experienced professionals can help craft solutions tailored to each family’s needs.
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