The impact of this change in the tax code regarding spousal support is national (not just North Carolina) and will effectively make divorce more expensive for many who rely on spousal support to maintain their standard of living. As the tax change of alimony applies to Court orders and separation agreements signed after December 31, 2018 those in the middle of divorce right now have just under a year to finalize any deal under the old/current law.
Current IRS alimony requirements
Current alimony tax law
The old/current law in effect since the Revenue Act of 1942 allows anyone paying spousal support such as post-separation support or alimony to deduct 100% of the money paid from their taxable income. The recipient is correspondingly required to claim 100% of the money received as taxable income as if they were issued a 1099 for the amount received during the year. As spousal support usually flows from the higher income earner to the lower income earner both parties are able to benefit via the difference in marginal tax rates between the parties. This means whoever is paying can afford to pay more since they realize massive tax savings. In effect the old/current tax treatment of alimony subsidizes divorce at the expense of the IRS.
Alimony under the old law
Under the old/current law if the Husband earns $120,000 per year as a salary and has to pay $30,000 per year in alimony to the Wife who makes $25,000 per year working then Husband would only pay taxes on $90,000 and Wife would pay taxes on $55,000.
Alimony under the new law
Under the new law if the Husband earns $120,000 per year as a salary and has to pay $30,000 per year in alimony to the Wife who makes $25,000 per year working then Husband would pay taxes on his full $120,000 yearly salary and Wife would pay taxes on just her $25,000.
Does the new law benefit those who receive alimony?
Although it may appear the new law helps those who receive alimony it will ultimately end up hurting both parties. Judges will likely order less spousal support as the payor will no longer be able to afford to pay the same amount under the new law as the old law. Also anyone paying alimony will offer less in settlement knowing they no longer can deduct amounts paid off their tax return. In essence both parties lose. The big winner will be the IRS who will be able to tax the high income earner at the higher marginal rate.
Why change alimony tax treatment?
As stated before the big winner of the new alimony tax law change is the IRS in the form of more tax revenue. Another possible motivation for the law is to make divorce more expensive perhaps reducing divorce rates. A declining divorce rate may be the long term result, but there may also be a short term spike as people rush to finalize agreements and court orders before December 31, 2018. Proponents of the change simply argue it gets the government out of the business of subsidizing and therefore encouraging divorce. Opponents argue that nobody separates and divorces to save on taxes. A final consideration is that it will help pay for the substantial personal and corporate tax cuts that are projected to cost $1.5 trillion over the next ten (10) years.
Relevant portions of PL 115-97, HR1, December 22, 2017, 131 Stat 2054
“(C) DIVORCE OR SEPARATION INSTRUMENT.—For purposes of this paragraph, the term ‘divorce or separation instrument’ means--
“(i) a decree of divorce or separate maintenance or a written instrument incident to such a decree,
“(ii) a written separation agreement, or
“(iii) a decree (not described in clause (i)) requiring a spouse to make payments for the support or maintenance of the other spouse.”.
(c) Effective Date.—The amendments made by this section shall apply to--
(1) any divorce or separation instrument (as defined in section 71(b)(2) of the Internal Revenue Code of 1986 as in effect before the date of the enactment of this Act) executed after December 31, 2018, and
(2) any divorce or separation instrument (as so defined) executed on or before such date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification.
What about old agreements or Court orders modified in 2019 and beyond?
The language quoted from the new law in the section above dealing with modification of instruments created under the old/current law seems to indicate the parties may choose to opt into the new tax law if the “modification expressly provides that the amendments made by this section apply to such modification.” This appears to be opt-in language that the parties control. This is good news as many alimony orders are modified and now it appears parties are free to do so without losing the tax advantages of the old law.
How will NC Judges react to the change in alimony tax treatment?
Alimony is based on the need of the dependent spouse and the ability of the supporting spouse to pay. The tax law change will almost certainly reduce the supporting spouse’s ability to pay and hence one would expect alimony awards to decrease accordingly. That being said, NC Judges still have wide discretion in determining spousal support and many do not seem to factor in the tax implications of an alimony award. As any ruling on alimony in North Carolina will not be overturned on appeal absent an abuse of discretion any potential change will likely vary from Judge to Judge.