You may have heard that alimony payments under newly executed divorce arrangements are no longer deductible for federal income tax purposes. This longtime deduction, which had been in place for about 75 years, was eliminated through one of the most controversial and well-publicized provisions of the Tax Cuts and Jobs Act of 2017.
With so much attention focused on loss of the federal deduction, there’s a related consideration that has received very little attention: alimony that is no longer deductible federally may still be deductible for state income tax purposes. This can be a very important point for couples seeking a divorce, especially in high-tax jurisdictions where the state tax deduction has higher value.
The federal alimony deduction had been a long-time staple in divorce planning. The old rule allowed the alimony payor to deduct their payments while the recipient paid income tax on any alimony received. The result enabled separating couples the opportunity to shift taxable income from the spouse earning more income to the one earning less. In cases where alimony was substantial, this tax treatment afforded the two individuals a valuable opportunity to save on their aggregate federal income tax bills.
The deduction also took some of the sting away from the ex-spouse who was paying the alimony. These potential benefits gave divorcing couples the ability to help defray some of the high costs of divorce, putting the alimony deduction at the center of divorce negotiations and among the top considerations by legal decision makers.
The Tax Cuts and Jobs Act of 2017 eliminated the federal alimony deduction for any alimony paid under divorce agreements executed after December 31, 2018. Additionally, previously executed divorce agreements may become subject to the new rule if an alimony modification agreement specifically states that the new law applies.
So, how do divorcing couples know if alimony is still deductible on their state tax return? It depends on whether and how your state follows the federal tax rules. This can get complicated, but generally, there are three ways:
In spite of the loss of the federal alimony deduction, a state deduction may still be available. For couples with prenuptial and postnuptial agreements, the potential impact of the law change remains to be seen. Considering that these agreements may have established alimony payments assuming the old tax treatment, the federal tax law change may have implications even for currently married individuals.
In simple terms, alimony planning may have become less important from a federal income tax perspective, but it can still be quite important from a state and local income tax perspective. In a sense, the repeal of the federal deduction may actually cause some to overlook the tax angle altogether – a trap for the unwary in states and localities that still offer the deduction. Because of the complexity of state tax laws, we recommend that you consult with a financial advisor, attorney, or accountant to see how this new law may affect you.
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