Are Divorce Fees Tax Deductible?

The council recently passed the most significant tax reform of all times and many people are wondering how it will affect them. Much attention has been paid to what deductions will be available to taxpayers, but some deductions haven’t received much attention in the press. In the end, changes to one such deduction may have a big impact on many Utah families: whether alimony paid is deductible from the payer’s income, and taxable as income to the recipient.

Alimony is awarded based on the recipient’s need and the payer’s ability to pay in Utah. Unlike child support there is no fixed formula for deciding alimony, and couples can agree on an alimony amount they consider to be reasonable, or the court can determine it when necessary.

Under current tax law, alimony payments are deductible to the payer and taxable as income to the recipient. We can use the example of a couple. Let’s say that Joseph earns $80,000 per year and Mary earns $20,000. They divorce, and Joseph is ordered to pay Mary $12,000 per year in alimony. Putting aside other deductions either of them might take, Joseph’s taxable income is now $68,000 while Mary’s is $32,000.

This, obviously, takes some of the sting out of having to pay alimony. With the new law, this deduction is going to be eliminated though not immediately. That means that if you have a plan to divorce, you have the chance to keep this deduction, that is if you are able to have a divorce decree entered in time.

Under the new tax law, alimony will not be deductible from income by the payer, nor will alimony payments count toward taxable income for the recipient. In the above example, even though Joseph is paying Mary $12,000 in alimony per year, Chris’ taxable income will remain at $80,000, and Lee’s at $20,000.

However, this only applies to those divorce orders that are entered or signed by the judge after December 31, 2018. Therefore, if Joseph and Mary have their divorce decree entered on December 30, 2018, the old tax law applies. If the decree isn’t entered until January 1, 2019, Joseph will lose the tax deduction for alimony payments he will pay more in income tax, and Mary will pay less.

Obviously, if you are in Joseph’s position, it is in your best interests to have that divorce ruling entered in 2018. You may even be inclined to be generous in agreeing to an alimony amount in order to ‘seal the deal’ and get your spouse to agree to a divorce settlement. After all, you can always go back to court later and have the amount of alimony modified downward if you need to. Is this true?

Yes it may be the case and no, it may not be the case. Utah divorce law does provide for the ability to modify an alimony award under certain circumstances, such as if the payer loses a job or becomes too ill to work and it is permanent in nature. As a general rule, though, the court will not reduce the amount of alimony unless good cause to do so is shown, or unless the ex- partners specifically agree. Even if you can get the judge to sign off on an alimony reduction, however, another risk awaits.

For the people who sought and receive a reduction in alimony payments after December 31, 2018, the new tax laws will apply, even if the original divorce decree was entered in 2018 or earlier. So let’s say Joseph, with an $80,000 income, agrees to pay Mary, with a $20,000 income, $12,000 in alimony each year. The divorce decree is entered in 2018, so Joseph’s taxable income is $68,000 and Mary’s is $32,000. Then Chris loses a job, and can only find a new job paying $60,000 per year. Meanwhile, Mary has gotten a better job and is earning $30,000 per year. Joseph decides to ask for a modification of alimony.

The judge agrees that Joseph’s ability to pay and Mary’s need have both changed, such that a reduction in alimony is appropriate. In 2019, alimony is reduced to $6,000 from $12,000. But now, since the new tax law applies, Joseph no longer gets to deduct that $6,000 from income. Joseph’s taxable income is now $60,000. On the other side, Mary no longer has to claim the alimony as taxable income, so Mary’s taxable income remains $30,000. In reality, however, Joseph only has $54,000 after paying alimony, and Mary has $36,000 after receiving it.

Conclusion: The change in tax law may make individuals who received favorable treatment under the old law think twice about pursuing a modification under the new law, particularly if the modification is likely to be small. The loss of the tax deduction might counteract the benefit of the reduction in payment.

The Child Tax Credit is now twice the original amount, that is, from $1,000 to $2,000. $1,400 of that amount is refundable, which means that if the credit reduces your tax bill to zero, you can receive the remaining amount of the refundable portion as a tax refund. In addition to this, the credit doesn’t even begin to phase out until income reaches $200,000 for a single taxpayer or $400,000 for a married couple. That means people who didn’t meet the requirements for the credit in the past will now qualify.

All of this sounds great, but the benefit will be limited for many of the people who need it the most. The refundable tax credit doesn’t kick in until a family earns at least $2,500 in income, so families with very little earned income won’t really see a benefit. The law also makes other changes that may offset the increased child tax credit, so that the benefit is not as great as it appears.