DEDUCTIBLE FOR THE PAYOR, TAXABLE FOR THE PAYEE — FOR HOW LONG?
Alimony, now known in New York as maintenance, has as its premise in the idea that the so-called “monied spouse” in a divorce should make payments to the non-monied spouse in order to allow the non-monied spouse time to become self-supporting. Back in the day, maintenance awards were often forever. Now that is much less frequent, the concept being not only to give the non-monied spouse a “soft landing” in terms of lifestyle, but also to get on her/his feet economically, perhaps completing an academic degree or other job-qualifying training. For federal tax purposes, maintenance payments have been deductible for the spouse who pays and taxable as income for the spouse who receives the payments. But not for long.
The sweeping tax overhaul passed in 2018 stands this on its head. Starting with cases that are resolved after December 31, 2018, maintenance (also called alimony or spousal support) will be paid with after-tax dollars, not deducted from taxable income, and would be tax-free to the recipient. For the spouse receiving maintenance, this makes sense, because the legislative rationale is economic rehabilitation. But for the spouse who pays, it’s more like an incentive to stay married. Maybe this is a good thing, socially speaking; after all, the divorce rate is approaching 50%. But where’s the social benefit from staying in a bad marriage? Does that help anyone? The spouses? The children?
Most seasoned family law attorneys I know are of the view that eliminating a tax deduction for high-income earners who make alimony payments will have unintended consequences not contemplated when the NYS legislature enacted the most recent legislation governing the calculation and payment of maintenance effective in 2016. One of the reasons is because the current tax deduction for alimony payers creates an incentive for high-earning spouses to pay larger alimony payments than they would under the new law. This means that if you do not reach an agreement or get divorced in 2018, the new law will change the negotiations of any divorce where spousal support is an issue.
Why did Congress make this change? The real reason is most likely that they needed to make it look like the tax law changes would not reduce revenue to the federal government, and eliminating the ability to switch who pays taxes on spousal support means that the monies are taxed at a higher rate, generating more federal tax dollars. This change in the law will increase taxes paid to the US government by $8.3 billion over ten years! But it also makes things easier for the IRS, which previously had to determine the deductibility of maintenance payments by checking to confirm they meet the following requirements, among others: the payment must be made pursuant to a written divorce or separation agreement; must be made to or on behalf of the ex-spouse; the obligation to make the payment must cease if the ex-spouse dies (failure to meet this requirement is probably the most common cause of lost alimony deductions); the payment must be in cash or cash equivalent; the payment cannot be considered child support, plus a couple of other requirements. With a 50% divorce rate, checking compliance is a big job!
Interestingly, the legal headstand returns federal law on this point to what it was in 1917, when the US Supreme Court ruled that alimony was not taxable to the spouse receiving it. That was the rule until 1942, when Congress overruled the 1917 case, passing the Revenue Tax Act of 1942. Except for gender-neutralizing language, federal law on the point hasn’t much changed since then. An interesting short article about this history is available here.
Given that this tax legislation passed, it is effective for agreements executed after December 31, 2018. This and potentially other changes in the tax code will need to be closely considered going forward in divorce negotiations.
If you are divorcing or contemplating divorce, please speak with your accountant and your attorney to help you navigate through it.