Is Alimony Taxable?

If you’re considering a divorce from your spouse and have lopsided incomes, then alimony might be a part of your divorce settlement. Alimony, also known as spousal support, is a payment one ex-spouse makes to the other following a divorce. As you begin planning your post-divorce life, it’s crucial to understand the tax implications of these payments for both the payer and the recipient. This leads to the question: Is alimony taxable?

The answer to this question has changed significantly in just the past few years, so it’s very important that you have up-to-date information. (No one loves getting an angry letter from the IRS!) This article will provide an in-depth look at the current tax treatment of alimony at both the federal and state levels, discuss recent changes in tax laws, examine potential exceptions, and explore strategies for minimizing the tax impact of these payments.

What Is Alimony?

Alimony is a legal obligation in which one spouse provides financial support to the other following a divorce. The purpose of alimony is to help the lower-earning spouse maintain a standard of living similar to what they had during the marriage. Alimony is typically awarded when one spouse earns significantly more than the other. This can also be the case if one spouse didn’t work in order to take care of the home or raise children.

The amount and duration of alimony payments can vary depending on factors such as the length of the marriage, each spouse’s income and earning potential, the age and health of both parties, and the standard of living established during the marriage. Typically, the longer the marriage and the greater the income disparity, the more likely alimony will enter into the equation.

Alimony can be paid in a lump sum or as periodic payments, and the duration can be temporary or permanent, depending on the specific circumstances of the case.

Keep in mind that alimony is different from child support. Child support is specifically intended to cover the costs associated with raising children, such as food, clothing, education, and healthcare.

When determining alimony, courts consider various factors to ensure a fair and equitable arrangement. These factors may include:

• The earning capacity of each spouse
• The length of time the recipient spouse would need to become self-sufficient
• The standard of living during the marriage
• Any sacrifices made by either spouse during the marriage (such as leaving the workforce to raise children or support the other spouse’s career).

Couples can also come to their own alimony agreement if they want to create a divorce settlement out of court, though the court will need to approve the divorce decree. If you think alimony is a possibility in your divorce, it’s imperative that you understand how alimony is taxed so you can better plan your post-divorce financial future.

The Recent Changes in Alimony Tax Law

Before 2019, the person paying alimony could deduct the payments from their taxes. This meant they could subtract the amount they paid in alimony from their total income before calculating how much they owed in taxes. On the other hand, the person receiving alimony had to report the payments as part of their income and pay taxes on it.

For example, if James paid his ex-wife, Courtney, $2,000 in alimony a month, or $24,000 a year, he could deduct that $24,000 from his taxable income. Courtney, however, would have to pay income taxes on the $24,000 she received from James.

Everything changed starting January 1, 2019, when the Tax Cuts and Jobs Act (TCJA) went into effect. Under the new law, alimony payments are no longer tax-deductible for the person paying them. This means that the payer can’t subtract alimony payments from their income before calculating taxes. At the same time, the person receiving alimony no longer has to report the payments as income or pay taxes on the money they receive.

In other words, if James and Courtney were to get divorced today, James would have to pay taxes on his full income even though he’s paying Courtney $24,000 a year in alimony. Courtney wouldn’t have to pay any federal income tax on the $24,000 she received. The new rules clearly benefit Courtney and force James to pay a higher tax bill.

The Reason Behind the Alimony Tax Change

Why did the government make these changes to the way alimony is taxed? They wanted to simplify the tax process and make it easier for everyone involved. Under the old rules, there was a lot of paperwork and room for error when reporting alimony payments on tax returns. The government also believed that the old system unfairly benefited the person paying alimony, as they could deduct the payments and pay less in taxes.

If you want to get cynical about it, the new changes also mean that the IRS will ultimately receive more in taxes, as higher earners are usually in a higher tax bracket than their lower-earning ex-spouses. If James is in the 35% tax bracket, he’ll pay $8,400 in federal taxes on the $24,000 he sent to Courtney. Alternatively, if Courtney is in the 12% tax bracket, she would have only paid $2,880 in taxes on that same amount.

Exceptions to Current Alimony Tax Laws

While the new tax laws for alimony apply to most divorce agreements made after December 31, 2018, there are a couple of exceptions you should know about.

Grandfathered Alimony Agreements

The first exception is for something called “grandfathered” alimony agreements. This means that if you and your ex-spouse signed a divorce agreement before January 1, 2019, the old tax rules still apply to your alimony payments. So, if you’re paying alimony under a grandfathered agreement, you can still deduct the payments from your taxes. And if you’re receiving alimony under one of these agreements, you still have to report the payments as part of your income and pay taxes on the money.

Voluntary Alimony Payments

The second exception is for voluntary alimony payments. These are payments that aren’t required by a divorce agreement but are made by choice. For example, let’s say James and Courtney divorced after 2018, so the new tax rules apply. But James decided to give Courtney some extra money each month while she went back to school to train for a new job, even though it wasn’t part of their divorce agreement. In this case, the voluntary payments James makes don’t follow the new tax rules. Instead, James can deduct these payments from his taxes, and Courtney must report the money as income.

It’s important to keep in mind that these exceptions can be tricky. If you’re not sure whether your alimony payments fall under one of these exceptions, it’s a good idea to talk to a tax professional or a lawyer who specializes in divorce.

How States Tax Alimony

As you know, when April 15th rolls around, you don’t just have to cut a check to the federal government. You also have to pay state taxes. Each state has its own laws about how alimony is taxed.

Most states follow the federal government’s lead when it comes to taxing alimony. So, if your divorce was finalized after 2018 and you’re paying alimony, the payments are probably not tax-deductible. And, if you receive alimony, you won’t have to pay taxes on that money. However, some states have different rules.

In California, Massachusetts, and Virginia, the old rules still apply for state taxes, even if your divorce was finalized after 2018. This means that if you’re paying alimony in one of these states, you can deduct the payments from your state taxes, and if you’re receiving alimony, you must report the payments as income on your state tax return.

It’s crucial to understand how your state’s tax laws apply to your alimony payments, as it can have a big impact on your tax bill. If you’re not sure about the rules in your state, it’s a good idea to talk to a local tax professional or divorce attorney. They can help you navigate the specific tax implications of alimony in your state and make sure you’re following the rules correctly.

Strategies for Lowing Your Alimony Tax Bill

If you find yourself paying alimony to your ex, the fact that you’ll be the one paying income tax on that money can feel like a double whammy. Fortunately, finding legal ways to lower your tax bill is a time-honored American tradition, and you may be able to save yourself from paying taxes on your alimony if you and your ex can negotiate an alternative.

Just a quick caveat, we are not tax experts by any means! Please always consult a tax professional before putting any of these strategies into play. (More on that next.)

Lump Sum Alimony Payment

One option is to make a lump-sum alimony payment instead of ongoing periodic payments. With a lump-sum payment, the paying spouse gives a one-time, large amount of money to the receiving spouse. Since this payment is made all at once, it’s not considered taxable income for the recipient or tax-deductible for the payer under the current tax laws. This can simplify the tax situation for both parties and potentially reduce the overall tax burden. Of course, the paying spouse will need to have the funds in order to make this strategy work.

Property Transfers

Another strategy is to use property transfers instead of alimony payments. In this case, the paying spouse gives the receiving spouse ownership of certain assets, like a house or a car, in lieu of regular alimony payments. By transferring property, both spouses can avoid the tax implications that come with traditional alimony payments. However, it’s important to keep in mind that transferring property can have its own set of tax consequences, so it’s best to consult with a tax professional before making any decisions.

Alimony Trust

A third option is to set up an alimony trust. With this strategy, the paying spouse puts money or assets into a trust, and the trust then makes payments to the receiving spouse. The trust is responsible for paying taxes on any income it earns. However, setting up and maintaining a trust can be complex and costly, so it’s important to weigh the potential benefits against the expenses.

It’s important to remember that every divorce is unique, and what works for one couple might not be the best solution for another.

These Professionals Can Help You with Alimony Tax Payments

Navigating the tax implications of alimony can be complex, especially with the recent changes to federal tax laws and the variations in state-level taxation. To ensure that you make informed decisions and minimize potential tax consequences, it’s crucial to consult with experienced professionals who can provide guidance tailored to your specific situation.

Ideally, you should consult with these experts before your divorce, so you can negotiate a divorce settlement that will protect your interests as much as possible. (Your spouse should do the same thing.) You never want to learn about a big new tax liability after the fact when you can’t change your divorce decree!

Tax Adviser

One key professional to consult is a tax advisor, such as a certified public accountant (CPA) or an enrolled agent (EA). These experts can help you understand how the current tax laws will apply to your future alimony payments and advise you on strategies to minimize your tax liability. They can also assist you in properly reporting alimony payments on your tax returns and help you avoid common pitfalls that could lead to audits or penalties.

Divorce Attorney

Another important professional to work with is a family law attorney who specializes in divorce. An experienced divorce attorney can help you negotiate an alimony agreement that takes into account the current tax laws and works in your best interest. They can also advise you on the potential benefits and drawbacks of different alimony payment structures, such as lump-sum payments or property transfers, and help you draft an agreement that clearly outlines the terms of your alimony arrangement.

Financial Planners

In addition to tax advisors and divorce attorneys, financial planners can also be valuable resources during the divorce process, including a Certified Divorce Financial Analyst (CDFA). A financial planner can help you assess your overall financial situation, create a budget, and develop a long-term plan for managing your finances after the divorce. They can also provide advice on how to invest any alimony payments you receive or help you adjust your financial plans if you are required to make alimony payments.

Never Guess When It Comes to Your Taxes

Understanding how the government taxes alimony is a critical aspect of navigating the divorce process. The recent changes to federal tax laws, along with the differences in how certain states tax alimony, have made it more important than ever for individuals to educate themselves on how alimony payments can impact their taxes.

By familiarizing yourself with the current tax treatment of alimony, exploring strategies to minimize the tax impact of these payments, and consulting with experienced professionals, you can make more informed decisions and work towards a more stable financial future post-divorce.

Remember, while the tax implications of alimony can seem daunting, you don’t have to navigate this complex landscape alone. If you’re considering divorce and want to learn more about the financial implications, including the tax consequences of alimony, consider attending a Second Saturday Divorce Workshop in your area.

These workshops are designed to educate and support individuals who are contemplating divorce, offering valuable insights and guidance from local divorce experts. During a Second Saturday Divorce Workshop, you’ll have the opportunity to hear from a range of professionals, including financial experts who can answer your questions about post-divorce taxes and help you understand how alimony payments may impact your financial situation. By attending one of these workshops, you’ll gain a clearer understanding of the divorce process and be better equipped to make informed decisions about your future.

Find your nearest Second Saturday Workshop.