Why is Alimony No Longer Tax-Deductible?
Divorce can be devastating, especially financially. The tax plan you were following when you were an "MFJ" (married filing joint) is now just a memory.
After your divorce agreement is finalized, the way you file your taxes moving forward must change. You'll once again be filing your taxes with the status of "single", and certain aspects of your agreement may have a significant impact on your tax return.
If your agreement includes alimony payments, you’re probably wondering if they might affect your return.
What is alimony?
Alimony, or spousal support, is a type of payment that helps one's former spouse or partner maintain a similar style of living as they were accustomed to before the divorce. These payments may not factor into every divorce arrangement, but they can provide significant assistance to someone who may not have been earning as much as their partner during their marriage and after their divorce.
Alimony is an official payment to a spouse under a divorce or separation agreement. It is one type of payment with a specific purpose. Other types of post-divorce payments such as child support, property settlements, or your former spouse's part of community property are not considered to be part of alimony payments.
Alimony and taxes
Beginning with the 2019 tax return, alimony will no longer be tax-deductible for certain people. According to the Tax Cuts and Jobs Act P.L. 115-97, alimony is neither deductible for payers nor can it be included as income unless it was included in a divorce decree that was finalized before 2019. If alimony was included in a divorce decree that was executed on or before December 31, 2018, it may continue to be deducted or included as income. If your divorce decree was executed on January 1st, 2019 or later, you cannot.
What caused the change in tax laws surrounding alimony?
So why has there been a change in how alimony is handled in taxes? The answer is simple: a tax gap.
The tax gap is a periodic estimate made by the IRS to measure overall compliance of all taxpayers with federal tax obligations. The gross average tax gap is made up of three main components: the non-filing tax gap, or taxes that are not filed or paid on time; the underreporting tax gap, or an understatement of tax reported on returns filed on time; and the underpayment tax gap, or an underpayment of taxes on returns filed on time.
In relation to alimony, the government was able to identify a discrepancy between the amount of alimony deducted by payers and the amount of alimony reported as income by its recipients.
An article published in 2019 by the American Institute of CPAs describes how this tax gap related to alimony was discovered. The Treasury Inspector General for Tax Administration (TIGTA) executed an audit and found a $2.3 billion alimony gap for 2010. In 2016, another audit was completed, and they found the tax gap increased by 38% to $3.2 billion.
For taxpayers deducting alimony payments, they must provide the tax identification number (TIN) for the person receiving the payments. Using TINs, TIGTA was able to find major discrepancies between deducted payments and reported income. In fact, in over 50,000 deductions (reflecting approximately $1.5 billion in returns), TIGTA found no corresponding returns filed by the recipients of the alimony payments. For another 2,168 returns, the TIN submitted for the recipient was simply invalid.
What does this change mean for your tax return?
As previously stated, alimony is no longer tax-deductible nor can it be included as income on tax returns if your divorce agreement was finalized as of 2019. For any divorce agreements that include alimony and were finalized prior to 2019, you may still continue to deduct payments or report alimony as income.
If you are still able to deduct alimony or report it as income on your tax returns for 2020 and beyond, don't be so quick to assume that this gap won't impact you. There may be more crackdowns on taxpayers who contributed to the discrepancy in alimony that was deducted or claimed on past returns. This could include fines issued by the IRS and increased audits on filers.
Tax preparers are not lawyers, and many times, preparers do not understand nor ask what is in the divorce decree. Be sure to spell out which items are deducted or included in income in your divorce agreements. As always, ask your lawyer to make sure you are protected from future crackdowns.
Lee Prinkkila is a Certified Public Accountant and Global Chartered Management Accountant who helps families and businesses navigate the arcane world of tax laws. In 1997, Lee prepared his first multi-state tax return for a professional athlete. Without the aid of the internet and great software, he continued navigating multi-state tax laws and an ever-changing federal landscape. Since that time, Lee has maintained his curiosity for tax law and building strategies to help people keep more of what they earn.
Along with owning his own CPA firm and preparing returns for over 20 years, Lee has lead teams and worked as CFO for various companies, both private and public. Currently, Lee serves as CFO of Tenenz Inc., one of the largest providers of tax research, products, and digital services to tax preparers in the country.