First, let me say that, as a family lawyer, I don’t give tax advice, but the following is what tax professionals I regularly work with, and with whom I consult with in helping my divorce clients, are telling me about significant changes to the tax code in relation to divorce cases and case planning.
Back in 2017, Congress repealed the long-standing alimony tax deduction, effective January 1, 2019. As a result, someone who pays alimony under a divorce decree or alimony modification that was finalized after January 1, 2019, can no longer deduct those payments from the taxable income for federal income tax purposes.
How Did the Alimony Tax Deduction Work?
Previously, individuals who paid alimony or spousal support to their former spouse under a divorce decree could deduct those payments from their taxable income. For example, if a taxpayer with an annual income of $75,000 paid $25,000 to their ex-spouse each year, the taxpayer effectively has only $50,000 of spending money for themselves. Under the alimony tax deduction, the IRS does not count the $25,000 the taxpayer paid to their former spouse as income for federal tax purposes (taxable income) and will only consider them to have $50,000 worth of taxable income. The taxable income a person has after factoring such deductions is called adjusted gross income or AGI.
The spouse who received spousal support was required to report it as income on their tax return for the year in which it was received. For instance, if an individual with annual earnings of $25,000 from their job received an additional $25,000 from their former spouse as alimony payments, they have $50,000 of spending money for themselves. As a result, the IRS considers them to have $50,000 worth of taxable income.
Under this example, both spouses essentially have $50,000 worth of spending money for themselves. As a result, the IRS would determine what each spouse owed in federal income taxes based on their respective AGI of $50,000
How Do Tax Brackets Factor into Everything?
A taxpayer’s AGI determines which tax brackets apply to them. A common misconception about tax brackets is that a single rate applies to an individual’s income. For instance, most people mistakenly think that if they have an annual income of $40,000 a year, they will owe 22% of $40,000 in taxes. But, in reality, tax rates only apply to the dollars you earn within the applicable tax bracket.
To illustrate how this works in simple terms, imagine a hypothetical tax system with just two tax brackets:
- 10% of earnings of $100 or less
- 20% of earnings over $100
Under this system, if a person earns just $100 for the year, their entire income falls within the 10% tax bracket. Therefore, they owe $10 in taxes (10% of $100). Now, imagine that someone earns $150 for the year. The taxpayer owes $10 in taxes on the first $100 of their earnings (10% of $100). However, $50 of the taxpayer’s income falls within the 20% tax bracket. As a result, the taxpayer owes another $10 (20% of $50) in taxes on that $50 of earnings. Therefore, under this hypothetical situation, a taxpayer who earns $150 for the years only owes $20 in taxes.
In reality, the IRS utilizes several tax brackets with progressive tax rates. For income earned in 2019, the IRS will tax single/unmarried taxpayers based on the following rates:
- 10% of earnings of $9,700 or less
- 12% of earnings over $9,700
- 22% of earnings over $39,475
- 24% of earnings over $84,200
- 32% of earnings over $160,725
- 35% of earnings over $204,100
How Do Tax Brackets Factor into Everything?
Because deductions can substantially reduce a taxpayer’s AGI, the alimony tax deduction allowed individuals to reduce their tax liability if they made spousal support payments. Applying the 2019 federal tax rates to our previous hypothetical, a person with an AGI of $50,000 only has to pay a 22% income tax on the $10,525 above $39,475. The other amounts are subject to lower tax brackets. However, without the alimony tax deduction, the non-deductible $25,000 spousal support payment is taxed at 22%. Therefore, the taxpayer owes $5,500 more in taxes without the alimony tax deduction.
Under the new rules, a person receiving spousal support does not have to add it to their AGI. Accordingly, if a person with an AGI of $25,000 gets an additional $25,000 in spousal support, they are not required to pay taxes on it. Although the spouse receiving spousal support experiences immediate benefits from this tax development, the spouse paying spousal support has a larger incentive to avoid or delay spousal support negotiations and minimize their total payment obligations. This cost can manifest itself as increased attorney’s fees due to more protracted litigation.
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