Alimony and Taxes, 2019 style

The recently-passed Tax Cuts and Jobs Act (TCJA) made some changes to the way alimony is handled, tax-wise, for divorces finalized in 2019 and thereafter. Essentially the change is to eliminate the deduction of alimony paid out by the paying party, while at the same time eliminating the inclusion of alimony received as ordinary income.

So, as the paying spouse in a divorce finalized in 2019 or later, you are not allowed to deduct alimony paid to your ex-spouse. This can result in a requirement to pay additional tax on money that you don’t get to use. The good news is that this new rule doesn’t change existing alimony provisions. If you are divorced as late as December 2018, your paid-out alimony is still deductible from your income, and will remain so as long as you are paying it.

As the receiving spouse, you will not have to include as taxable income any alimony paid to you from your ex-spouse. This means that you won’t have to pay tax on alimony received if your divorce is finalized in 2019 or later.

If you’ve been following this, you might have noticed that it’s a bit unfair, when compared to the current situation. After all, the way alimony has been handled up to this point has put the tax burden on the person who receives the economic benefit of the money. With this change, the person receiving the alimony owes no tax, while the person paying it out must pay tax on that money as if they had it to spend.

Under today’s rules, the payor of the alimony agrees to the arrangement (and amount) in part because of the deduction. The recipient is agreeable to the arrangements because he or she has received the money and can use it. Often the recipient is in a lower tax bracket than the payor spouse, as well. This is likely to make changes to alimony arrangements – because both the payor and the recipient are likely to feel the pinch.

This is because, since the payor can no longer deduct alimony paid out, he or she is likely to want to pay less in order to compensate for the tax that must be paid. As a result, the recipient will then receive a lower alimony payment.

So – you’re probably wondering… is there a way around this? Turns out, there is. It’s not a panacea, but it could help.

Paying alimony, 2019 style

One way around this issue is to include retirement funds in your settlement process, rather than or along with traditional alimony.

For example, if part of the divorce agreement requires you to transfer funds from an IRA to your ex-spouse’s IRA (in lieu of alimony), you would no longer have to pay tax on money withdrawn from the IRA, but your ex-spouse would. The transfer of funds to your ex’s IRA would be a one-time event, rather than a regular payment from the IRA. This would only work when the recipient is at or near age 59 1/2, since withdrawals from the IRA prior to that age would be subject to the additional 10% early withdrawal penalty.

This sort of arrangement could be used to partly or completely offset alimony paid in the traditional sense – and would revert the tax burden to the recipient.

(You should also note that this is not the same thing as a QDRO. The rules for QDROs, which only apply to 401k and other employment retirement plans and NOT IRAs, did not change with TCJA.)

If you’re facing a divorce in 2019 or later, you will want to consult a financial planner to help make sure you’re making the right moves, no matter which side of this you find yourself in.

On the other hand, since alimony received is no longer considered earned income to the recipient, he or she will no longer be allowed to make IRA contributions based on the alimony received. If the recipient is not otherwise employed, IRA contributions will not be possible. This could be another reason that the IRA transfer process would be beneficial to the recipient ex-spouse.