Alimony: The New Frontier?

By Orlando Gotay, Tax Attorney

There are many provisions in the new federal tax bill HR 1, rolled out recently by the House Leadership. The bill was marked up by the Ways and Means committee and should move soon to the floor. One provision stood out in my eyes: Taxation of alimony.

The way it is today, alimony is 100% deductible to who pays it, and is included in the income of the recipient. Alimony payments are made to a spouse or former spouse under a divorce or separation agreement in cash; the persons are not part of the same household, do not file jointly, and obligations to pay do not continue past the death of the recipient spouse. Some people try to disguise property settlements as alimony, and there are rules to prevent that (mostly when the “alimony” is front loaded into the early years after separation or divorce). Alimony does not include child support or other payments between spouses.

The way it would be if the bill becomes law: Alimony would no longer be deductible, and it would then be tax free to the recipient. This is a huge difference from what it is now. I can see how this would impact many former spouses who figured a dollar amount for alimony payment, counting on the value of the tax deduction.

Another aspect worth noting: Under the possible new scheme, if alimony is paid to a former spouse who is a nonresident alien (remember, some of you marry local nationals and later divorce them) then the alimony payment to that nonresident alien former spouse would be, as mentioned, tax free and may not be subject to withholding. Recipient spouses stand to gain and the ones paying stand to lose big time if this becomes law.

You probably wonder if the current Congress has something against divorced people; some have said as much. I see a different reality. Congress is looking for “pay fors” provisions that can be changed to increase revenues without the corresponding backlash. This is one of them. Why does this raise revenue? Well, most people who pay alimony are in a higher tax bracket than the ones who receive it.

What to do? If this becomes law, it may be useful to try to get former spouses back to the table and renegotiate a new alimony amount taking into account the new reality. Those who have prenuptial agreements may want to revisit them. Those who are in the process of getting divorced should pay critical attention to how this plays out.

 

Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the US Tax Court and other taxing agencies. His love of things Mexican has led him to devote part of his practice to the federal and state tax matters of U.S. expats in Mexico. He can be reached at tax@orlandogotay.com or Facebook: GotayTaxLawyer.

 

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