The Tax Cuts and Jobs Act and Divorce

The Tax Cuts and Jobs Act is expected to be signed into law before the end of 2017. Regardless of your political view, there are sweeping changes that will almost certainly affect your finances. This article looks at one very small, but significant, change that is likely to become part of the final legislation.

Under Section 61(a)(8) and Section 71(a) of the Internal Revenue Code, as it exists before the new law, “alimony and separate maintenance payments” were expressly included in the recipient’s gross income and were subject to tax. By the same token, a spouse who paid alimony was entitled to deduct the alimony or separate maintenance payments that he or she made in the year. 26 U.S.C. §215.

The Tax Cuts and Jobs Act has now deleted these provisions. In other words, the spouse who receives alimony or maintenance will not have to report the income nor will he or she be taxed on it. Similarly, the spouse who is paying alimony or maintenance will not receive any tax deduction for the same. Importantly, these changes will not impact divorce decrees or separation agreements that are entered on or before December 31, 2018. The language of the bill provides:

“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.”

Under Section 71(b)(2), the term “divorce or separation instrument” basically includes both a decree issued by a court, or a written separation agreement. Therefore, it appears that any decree or order issued before the end of 2018 will continue to require inclusion of the money received as income, while permitting the payor spouse to deduct those payments. It is entirely unclear under what circumstances it would benefit the parties in a modification proceeding to want to include a provision that would make the Tax Cuts and Jobs Act applicable to themselves. While certainly the recipient spouse would enjoy the benefit of tax-free income, the payor spouse is unlikely to maintain payments at the same or increased levels without the benefit of deductibility.

Effective January 1, 2014, the Colorado General Assembly passed a state law containing guidelines for the award of spousal support. The Colorado statute was enacted at a time when maintenance was tax deductible. The tax consequences associated with a maintenance obligation is frequently an important component in litigating or settling dissolution of marriage proceedings. Unless the Colorado lawmakers alter the maintenance guidelines, the payor spouse could be saddled with a large award (computed on the basis of gross income figures) that he or she can no longer deduct. It would certainly be expected that, following the passage of the Tax Cuts and Jobs Act, the maintenance guidelines would be significantly altered to account for the non-deductibility of maintenance. In either case, it appears that settling dissolution of marriage cases that involve the potential for maintenance will become increasingly difficult after December 31, 2018.

by: Craig A. Weinberg.