While divorce is an emotional and financial strain on many Californians, they are finding that there’s an unexpected tax surprise in the mix when they’re considering negotiating or changing spousal support obligations. Making a simple change to a divorce agreement may mean substantial tax implications for both the former husband and wife, which can last for years.
The controversy is due to changes that were made after the federal Tax Cuts and Jobs Act (TCJA) phased out the tax deduction for alimony payments in numerous situations. There may be tax rules that apply to older agreements that are still in effect that may qualify for favorable treatment, but changing the agreements could result in an entirely different set of tax rules. Look for an expert (like a criminal tax attorney in Los Angeles) who can manage your affairs.
Knowing these rules prior to signing any changes may save you thousands of dollars.
Change in Alimony Tax Rules
In the previous system:
- Typically, the paying spouse could deduct the alimony costs.
- The spouse receiving the alimony claimed the alimony as income.
If you entered into a divorce or separation agreement after December 31, 2018:
- The recipient typically does not report alimony received as income in the year that it was received.
- The entire after-tax expense of the spousal support is paid by the paying spouse.
This means that many payers end up with a much greater financial responsibility than they bargained for.
The Secret Risk of Altering Agreements from the Past
One of the biggest traps is to agree to pre-2019 divorce agreements.
Many ex-spouses believe they can make “easy” changes without impacting tax treatment. Some changes might lead to the loss of the grandfathering status and apply to the new rules.
Some frequent alterations are:
- Adjusting payment amounts
- Extending support periods
- Revising support schedules
- Renegotiating divorce settlements
- Including new finance arrangements
Both sides should be aware of the possible tax implications before making any agreements. Hire an expert (like a criminal tax attorney) if you are facing some major tax issues.
Why is this Expensive?
If the spouse is paying, then:
- Deductions at either the state or federal level may not be available.
- Revenue is still higher.
- Effective support costs increase.
If the spouse is to benefit, then:
- Support payments may be received without paying taxes on them.
- Income reporting requirements can be reduced.
- Leverage in the negotiation can change in settlement negotiations.
Both sides need to thoroughly review the calculations of support based on the new tax burden distribution.
Smart Negotiation Strategies
Divorces should not be defined solely by monthly alimony payments, but by other financial planning options.
Potential strategies include:
- Emphasize Property Division
One of the reasons for this is that a bigger share of marital property can often be more tax efficient than increased support payments later on.
- Consider Tax-Advantaged Assets
Certain long-term investments, retirement accounts, and other assets can offer more flexibility in proper structure.
- Evaluate Lump-Sum Settlements
In certain cases, there will be a settlement that will remove future uncertainty and the risk associated with future modification.
- Examining the Whole Financial Picture
When negotiating, take housing expenses, retirement plans, investment income, and future income into consideration.
Tips to Avoid Expensive Pitfalls:
If you are considering changing any divorce agreement:
- Seek the advice of a professional family lawyer.
- Consult a tax advisor who is knowledgeable about California tax regulations.
- Ask for estimates with the old and new tax rates.
- Record any changes made.
- Consider all cash-flow and all long-term financial implications, not just the immediate cash-flow.
The current tax structure regarding alimony has completely revolutionized the way alimony should be negotiated in California. An overlooked change in an existing agreement can have unintended tax implications and make a huge impact on the cost to the paying spouse.
