Federal tax reforms from the newly passed ‘Tax Cuts and Jobs Act’ (TCJA) took effect Jan. 1, 2018, and impacts all citizens filing tax returns in 2019.
While most Americans will fixate on the size of their refund, divorced taxpayers (and those considering divorce) should consider how these changes will affect their alimony agreements signed after Dec. 31, 2018.
Alimony is No Longer Tax Deductible for the Payer (for Agreements Signed after Dec. 31, 2018)
Higher-earning spouses traditionally agreed to more generous alimony arrangements because they could write off the payments as tax deductions. The payments were taken off the top of the payer’s entire taxable income, which allowed some individuals to file in a lower tax bracket (and at a lower tax rate).
This is no longer the case. Under the new tax law, there is no tax benefit to making alimony payments for agreements signed after Dec. 31, 2018. This will undoubtedly have an impact on the settlement strategies of higher-earning spouses.
Alimony is No Longer Taxable Income to the Recipient (for Agreements Signed after Dec. 31, 2018)
According to the new tax law, alimony payments are no longer considered taxable income for the recipient. This would appear to be a major financial windfall, especially considering the recipient is usually in a lower tax bracket than the payer to begin with.
But not so fast- judges take several criteria into consideration when determining a spousal support arrangement, including the tax implications of alimony payments. If the payer can no longer afford bigger payments without the tax deduction, the judge may agree to smaller payments. Or the parties may agree to a lump sum divorce settlement instead. Both options could leave the recipient with less money overall.
In addition, the recipient may also have to revisit his/her retirement strategy. Retirement account contributions often require the use of taxable income, which will force the recipient to find the contribution money from somewhere else.
Divorcing Couples Have Until 2019 to Settle Under the Old Rules
The new tax law will affect all divorce agreements signed after Dec. 31, 2018.
Divorces settled before this date will be grandfathered in under the old tax rules. This grandfathered arrangement will be voided, however, if an old agreement is modified after the Dec. 31 deadline, and specifically states the TCJA treatment of alimony now applies.
Divorce experts worry this will create a rush for higher earning spouses to get divorced before the deadline, whether couples are truly ready to end their marriage or not. It may also cause the likely alimony recipient to delay all divorce proceedings until 2019 to get the tax benefit. Attorneys will also be on the lookout for alimony modification requests in 2019 that are intended to take advantage of parties not aware of the new tax law’s implications.
What Does This Mean for New Jersey Divorce Cases?
All divorce cases must be compliant with federal and state law. Be aware: The State of New Jersey recently passed some reforms of its own that directly impact alimony arrangements.
In 2014, Governor Chris Christie signed an alimony reform bill that removed the concept of “permanent alimony” and replaced it with “open durational” alimony. For marriages lasting fewer than 20 years, the duration of payments cannot exceed the lifetime of the marriage with little exception.
For example: If you were married for two years, the duration of alimony payments cannot exceed two years.
Divorcing couples in New Jersey must take these additional restrictions into consideration when negotiating a spousal support agreement.
Will the New Tax Law Affect Prenuptial Agreements?
Yes. If your prenuptial agreement contains alimony provisions based on the old tax law, it needs to be reworked. Remember, divorce settlements before Dec. 31, 2018, will be grandfathered in under the old rules, not premarital agreements. What made sense financially in a prenuptial agreement a few years ago may no longer make sense in 2019.
Hire a North Jersey Divorce Lawyer
The divorce attorneys at Arons & Solomon work with a team of experts, including Certified Financial Planner™ professionals and CPAs, to help people create divorce settlements that meet their financial needs.
To gain peace of mind that you are getting the most out of your existing or pending alimony arrangement, contact us today.