New Tax Law Has An Expensive Trap for Payers of Spousal Support (Maintenance).
By Fred Klarer, Divorce Mediator Attorney at our Long island Divorce Mediation Suffolk County Centers, Huntington, and Yaphank. (Our Divorce Mediation Services)
Spousal Support & 2018 Tax Law Changes – How is Spousal Support Calculated?
Often in divorce one Spouse ends up paying Spousal Support (“maintenance” or “alimony”) to the other. In New York, to set Spousal Support or Maintenance, we have a formula that Judges are required to use, established by the New York State Legislature. Judges can vary it, but Judges generally follow the rules as set out by the Legislature.
Spousal Support kicks in when there is a large gap between the income of the two Spouses. The formula awards the Spouse who makes substantially less a monthly maintenance award that boosts the income of that Spouse.
There are guidelines suggested for how long the Maintenance payments should last, but it is usually left up to the Judge. A rough and ready rule-of-thumb is one year of maintenance for three years of marriage. However, it is up to the Judge’s discretion.
Spousal Support & 2018 Tax Law Changes – The Pre-2018 Rules on Tax Deduction or Liability Regarding Spousal Maintenance.
In the past, any Spousal Support payment was a tax deduction to the one who paid it. It was taxable income to the one who received it. So, a sizable monthly Spousal Support payment reduced the income tax due from the Spouse who was paying it. It increased the income tax payable from the one who received it.
Sometimes the Maintenance payment to the Spouse with lesser income taxes had a big impact. It changed that person from someone who paid no income tax to someone who had taxable income.
All that has now changed.
Spousal Support & 2018 Tax Law Changes – Deduction of Spousal Support (Maintenance) Prior to January 1, 2019
For any Stipulation of Settlement or Separation Agreement signed prior to January 1, 2019, maintenance will still be deductible for the one who pays this Spousal Support. It will be taxable to the one who receives it.
As I write this, this deadline of January 1, 2019, is only 7 months away. If you are in the process of divorce you need to know those deadlines.
New IRS Rules and Deduction of Spousal Support (Maintenance) After January 1, 2019
The new Internal Revenue Service changes apply to any Stipulation of Settlement, settling the terms of a divorce signed after January 1. 2019. They also apply to any Separation Agreement, signed after January 1, 2019.
For those divorces or separations:
Spousal Support will no longer be an income tax deduction for the person who is paying the support.It will not be included as additional taxable income for the person who will receive the support.
Spousal Support & 2018 Tax Law Changes – How These New IRS Rules Will Impact Divorce Negotiations
This is not such a simple issue as it might seem.
Currently, the person paying Spousal Support receives a tax benefit. The person receiving Spousal Support may have to pay additional income tax on the received money.
That has make certain choices in negotiating Spousal Support clear. Here is an example:
Now, (before January, 2019), let’s assume a former or legally separated Spouse retains the use and occupancy of the marital residence. This Spouse elects to indirectly receive Spousal Support by having the other Spouse pay the mortgage, taxes, and homeowner’s insurance directly to the bank.
In other words, this Spouse residing in the marital home does not receive a Support payment in his or her name. He or she does not show an increase in income and thus an increase in income tax.
Meanwhile, the Spouse paying support gets his or her tax benefits by deducting the real estate payments rather than by deducting Spousal Support. Since the real estate payments are often larger deductions than the Spousal Support, the paying Spouse pays less in taxes. Win-Win.
For any agreement signed after December 31, 2018, the above trade-off strategy will not help either party pay less in taxes. That is because the person paying the Support will no longer receive any tax benefit for paying maintenance. It doesn’t matter whether he or she pays the Support directly to the Spouse or indirectly to the bank. He or she must pay full tax on the money. It is no longer deductible to this Spouse.
The person receiving the Support will pay no taxes on it, so he or she does not need the trade-off strategy in order to save on taxes.
The outcome of this is clear. It makes negotiation of support amounts much more difficult.
The person paying Support will have to make more money to pay the same amount in Support.
The person receiving the money will not typically understand or appreciate that the person paying Support will have to pay the taxes on the Spousal Support, thus further reducing the paying Spouse’s income.
Spousal Support & 2018 Tax Law Changes – Additional Spousal Support Guidelines:
A couple of other interesting issues to note are these:
1. Before January 2019, after the Stipulation of Settlement or Separation Agreement is signed, both Spouses need to live in separation residences and not file a joint income tax return. That is the only way that Spousal Support payments can be deductible on the paying Spouse’s federal tax return.
2. Before and after January 2019, Spousal Support obligations must terminate with the death of the person receiving them. You cannot leave any remained Spousal Support payments to your children. You could use insurance to leave that amount to your children.
Next Blog: How the Maintenance Changes Affect the New York State Maintenance Formula.
If you would like to learn more about our divorce mediation services at the Long Island Center for Divorce Mediation, please call or email us. We have two convenient Long Island Divorce Mediation nearby offices in Huntington and Yaphank.