Under the 2017 Tax Cuts & Jobs Act, spousal support is no longer tax deductible on the Federal level for the person paying the support. As discussed in a previous post, the law shifted responsibility of paying the tax from the payee (i.e., the spouse receiving the support) to the payor. This change applies to divorce agreements entered into after December 31, 2018.
The law was likely passed to generate additional revenue for the government by eliminating the deduction for the payor spouse who would be in a higher tax bracket than the recipient spouse. Under the old law, the recipient spouse paid the tax, but he or she would pay less because typically the recipient would be in a lower tax bracket.
In the end, however, the law changed spousal support negotiations because a big incentive to get the payor spouse to settle spousal support was its tax-deductibility.
Given the tax landscape we currently find ourselves in, there are arguably at least two approaches to negotiate spousal support going forward.
- Calculate how much the payor lost in the Federal tax deduction for the amount of the spousal support to be paid and deduct that from the spousal support payment. Thus, the payor spouse is compensated for the lost deduction at the expense of the recipient spouse who generally pays less in tax than the payor spouse when the payor spouse’s income is in a higher tax bracket.
- Calculate the Federal tax the recipient spouse would have paid on the spousal support income if the law hadn’t changed and deduct that amount from the payor’s payment. This shifts the loss to the payor resulting from the difference between the lost deduction and the calculated tax liability for the payee if the payment were taxable to him or her.
Some courts have decided that the amount of tax the recipient spouse would have paid if the support payment was taxable to them should be deducted from the payment paid by the payor spouse (Option 2 above). As a matter of public policy, these courts prefer to keep the recipient spouse in the same position as he or she would have been in but for the tax law change, rather than to pass the full cost resulting from the tax law change on to the recipient spouse.
Notwithstanding this change in Federal law, however, spousal support is still tax-deductible to the payor and the payee spouse will pay taxes on the support received as income for New York State and local income tax purposes. As a result, it is more important now than ever to take into consideration various settlement possibilities and how they will affect the parties’ tax bill under very different Federal and state laws.
If you are divorcing, consult an experienced attorney and financial expert to negotiate the best result in your matter. Contact us for a consultation to learn how we can help you.