Year-End Tax Planning: Divorce and Alimony

If you’re just beginning the difficult process of divorce, there may be extra incentives to do it quickly, before year-end. For high-income taxpayers, now might be the best time to get divorced. At least, according to the new tax law.

Why rush through the divorce process before December 31, 2018? A big reason is because starting in 2019, alimony payments will be non-deductible. Divorce agreements that are finalized before year-end will still allow alimony to be tax deductible, saving the paying spouse potentially thousands of dollars.

The New York Times estimates that around 600,000 taxpayers claim the alimony deduction each year. This deduction reduces total taxable income, and when payments can go on for a decade or more – or permanently – it’s a tax break that the paying spouse is loathe to lose.  

On the other hand, beginning with January 1, 2019 alimony payments received will no longer be included in taxable income, just like child support payments. Therefore, while the spouse receiving payments may want to wait to finalize divorce agreements, it could be in both spouses’ best interests to move ahead with the divorce before year-end. Why?

The new tax law will likely mean the payor will want to negotiate a lower amount to compensate for the lack of any tax breaks. Depending on the state, this could further complicate divorce settlements and the receiving spouse could end up with less money overall. This depends on both spouses’ tax brackets in 2019 and beyond, as it may make sense in some cases to delay divorce proceedings if the paying spouse will be in a lower tax bracket, or the receiving spouse in a higher one.

In addition to losing the alimony deduction in 2019, unallocated support payments will no longer be deductible. If faced with a divorce agreement that cannot be finalized before year-end, more complicated work-arounds will likely be needed, involving shifting the balance of assets and using tax-exempt retirement accounts to pay alimony. Taxpayers should know that even using an IRA to pay spousal support is taxable.

Another reason to finalize divorce agreements before year-end is the treatment of the dependency exemption, which sunsets after 2018. The question of who gets to claim which dependents on their taxes will soon be a moot point and could change divorce agreements between parents of minor children.

Then, there’s the child tax credit. The child tax credit increased for 2018 through 2025, from $1,000 per qualifying child to $2,000. For divorced or separated parents, it will be important for tax planning purposes to know who claims the credit for 2018 and subsequent years. The custodial parent can waive the child tax credit in one or more years using Form 8332, but this must be documented with the tax return.

Depending on your state, there are specific rules for calculating alimony that may leave more – or less – room for negotiations. And some states also have what’s known as a “cooling off” period, or a waiting period, between when the divorce agreement is signed and when it is considered finalized.

If you find yourself in the beginning or middle of a divorce and any of these rules apply to you, please contact your CPA to work with your attorney to help you negotiate the best possible settlement for tax purposes. Divorce is a situation we never want to be in, but the knowledge and support of experienced professionals can make the process a little easier. Contact Naden/Lean if you have questions.