When President Trump signed the Tax Cuts and Jobs Act last year, it made some changes to how spousal support (alimony) and child support are treated for tax purposes. Alimony is no longer tax-deductible for the paying spouse, which will change the incentives during negotiation. Furthermore, tax exemptions for dependents have been eliminated, so you will be relying on the child tax credit for any tax relief. You should also be aware of the need for a QDRO when dividing retirement accounts.
Alimony is no longer deductible on your federal taxes
One of the more interesting changes to the tax code made by the Tax Cuts and Jobs Act was the elimination of the tax deduction for payers of alimony. Unfortunately, the effect of this may be an overall reduction in how much alimony is paid out.
Florida law offers several different types of alimony (spousal support), which serve different purposes. On one end of the range is temporary alimony, which is provided to the lower-income spouse during the divorce itself. On the other end is permanent alimony, which is awarded when the lower-income spouse is likely to need the financial support permanently because they lack the ability to support themselves at the marital standard of living.
Under previous law, alimony was tax-deductible for the payer and was considered taxable income for the recipient. Practically, that meant that the paying spouse’s obligation could be a bit smaller than the actual order.
That meant that, during divorce negotiations, there was an incentive to categorized payments made from one spouse to the other as alimony, where possible. Now, that incentive has been removed, so negotiating couples may decide the lower-income spouse should receive a greater share of their assets during property division, thus reducing the alimony obligation.
Dependent exemptions have been eliminated
The federal tax exemption for dependents — children and adults in guardianship or conservatorship — has been eliminated. This exemption allowed you to subtract $4,050 from your taxable income for each child or dependent you had. If your dependents are children under 18 and you meet certain income requirements, an increase in the child tax credit to $2,000 per child will help offset the lost exemption.
When dividing retirement assets, get a valid QDRO
If you or your spouse contributed to a retirement account during the marriage, those contributions and corresponding increases in the account are likely to be considered marital property. If your IRA or 401(k) is marital property, it will need to be divided as part of your divorce.
What many people don’t realize is that, for this division to be done properly, it must be done by court order. The type of court order is called a qualified domestic relations order, or QDRO.
The reason you need a QDRO is so that you don’t incur taxes and early withdrawal penalties. If you were to withdraw part of the account and turn it over to the other spouse, you would be required to pay back taxes and, assuming you are not 59-1/2 or older, a penalty for withdrawing the money before retirement.
When transferring retirement accounts during divorce, the destination account should also be a tax-advantaged retirement account. The transfer should be performed by the originating account’s administrator, not you. However, the plan administrator has no authority to transfer funds to a third party without a QDRO that complies with the plan rules.
When you are negotiating for the division of property and debt, alimony or child support, it is crucial to understand the tax implications of your decisions. Those implications could substantially affect the monetary value of your divorce settlement.
