Tax Cuts Part II

It seems an obvious understatement to say that tax planning during the second half of 2018 should be easier than it was during the second half of 2017. The Tax Cuts and Jobs Act of 2017 (TCJA), which was enacted in 2017 but largely became effective at the beginning of 2018, changed many of the fundamental underpinnings of tax planning, including in the areas of tax rates, estate taxes, expense deductions and choice of business entity. Making matters even more challenging, the year-end timing of the new legislation forced planners to work quickly to understand and then incorporate the new rules into their client plans for 2017 and 2018.

It is now appropriate to turn our focus to some of the tax provisions that have not yet become effective. With only a quarter to go in 2018, time is running out to consider the key provisions of the law that will become effective starting next year. We’ll call these provisions “Phase II” of the law. Planning for Phase II—or not planning for it—can make a substantial difference for many people.

Phase II, Part 1: Repeal of the Deduction for Alimony Payments

What is it?

Currently, for federal income tax purposes, alimony and separate maintenance payments (which we’ll call collectively “alimony payments”) are deductible from the taxable income of the payer as long as they are includible in the taxable income of the payee under the applicable provisions of the Internal Revenue Code. The alimony deduction is an “above-the-line” deduction included in the calculation of adjusted gross income (AGI), often increasing the net value of the deduction.

Under the TCJA, this well-settled, long-standing tax principle is set to change—dramatically. Alimony payments made under a divorce or separation instrument executed on or after January 1, 2019, will no longer be deductible from the taxable income of the payer or includible in the taxable income of the payee.

What are the key planning implications?

Normally, the income of the payer of alimony payments is higher than the income of the payee. Therefore, under the law as in effect today, through careful use of the alimony deduction, taxable income may be shifted away from the ex-spouse subject to higher marginal tax rates to the ex-spouse subject to lower tax rates. Under the new law, however, the deduction no longer will be available, so ex-couples may owe more in aggregate taxes.

While the loss of the ability to shift income is the most obvious new dynamic, keep in mind that the TCJA also may have an impact on the divorce resolution and settlement landscape. Under the TCJA, negotiation and adjudication may become more difficult. Currently, because of the deduction, alimony is less costly after taxes for the payer and more costly for the payee. With the loss of the deduction, payers may be less likely to agree to an alimony arrangement, and, as a result, negotiation and adjudication may be more difficult.