More than three years have passed since the Tax Cuts and Jobs Act (TCJA) fundamentally changed how alimony is treated for federal tax purposes, yet confusion still reigns among many family law and tax professionals. One of the most common questions in this author’s experience is “Does modifying an alimony agreement that was in place prior to the TCJA cause alimony to become not taxable to the recipient spouse and not deductible for the payor spouse?” This question is frequently followed up with “Did we have to have the final decree of divorce or separation in place on or before December 31, 2018, to achieve deductibility for the payor spouse and income inclusion for the recipient spouse?
Although to the best of this author’s knowledge there has been no tax litigation to date on either of the above questions, a close look at the law as written, and subsequent IRS unofficial guidance would seem to indicate that the answer to both questions is “no”.
In tax law to have a true understanding of the new – one must first understand the old. So, it is with the repeal of IRC Section 71, the part of the tax code that governed the taxability/deductibility of alimony seemingly since Moses came off the mountain with the stone tablets.
The TCJA struck Section 71 generally effective for any divorce or separation instrument (as defined in Section 71(b)(2) in effect prior to December 22, 2017) executed after December 31, 2018.
Prior to TCJA, to qualify as alimony under the dearly departed IRC Section 71, payments to a spouse or former spouse had to meet all of the following criteria:
- The payment must be made under a written divorce or separation instrument.
- The spouses must not live together after the final decree of divorce or separate maintenance.
- The payments must be made in cash or cash equivalents.
- The payments must be made to, or for the benefit of a former spouse.
- The divorce or separation instrument must not designate such payment as not includible in the gross income of the recipient spouse, and not allowed as a deduction to the payor spouse. (Yes, the text of the law uses a double negative in this instance.)
- The couple must not file a joint return for the year at issue.
- The payments must cease upon the death of the recipient.
- The payments must not be named as child support in the divorce instrument – or later deemed to be child support.
If all of the above boxes were checked the payments were considered alimony—period.
It should be noted that for states that did not conform to the TCJA (which includes California), the above IRC Section 71 rules remain alive and well.
The TCJA of course rendered all of the above moot for federal purposes if the divorce or separation instrument was executed after December 31, 2018. Therefore, assuming all the right boxes are checked, the key to post-December 31, 2018, deductibility/taxability of alimony is determined by the following two factors. 1) The date the divorce or separation instrument was executed, and 2) The definition of a divorce or separation instrument.
IRC Section 71(b)(2) as in place prior to December 22, 2017, defined a divorce or separation instrument as:
- A decree of divorce or separate maintenance or a written instrument incident to such a decree, or
- A written separation agreement, or
- A decree requiring a spouse to make payments for the support or maintenance of the other spouse.
Note that items 2 and 3 do not require a “Final Decree of Divorce or Separation”. Furthermore, item 2, “A Written Separation Agreement” need not necessarily originate from a legal proceeding in order for payments to meet the definition of alimony for tax purposes. For example, in Leventhal v. Commissioner (TC Memo 2000-92) the court ruled that correspondence between the divorcing couple’s attorneys demonstrated a written “meeting of the minds” sufficient to comply with the requirements of IRC Section 71(b).
Therefore, even if you did not have a court order for alimony prior to January 1, 2019, so long as “a written separation agreement” was in place prior to that date, the post-December 31, 2019 payments would still be considered deductible/taxable alimony assuming the other seven of the eight criteria previously mentioned are met.
The next logical question is — Can an alimony agreement that was in place prior to January 1, 2019, be modified without negating the deductibility/taxability of the payments? The answer would appear to be a QUALIFIED yes, although the ground here is not as firm as one might like due to the fact that this part of the tax law is in its infancy. However, IRS has offered some informal guidance via publications and web postings.
In an update to Publication 5307 “Tax Reform: Basics for Individuals”, posted March 3, 2021, IRS stated that generally alimony is deductible by the payor, and includible in the gross income of the recipient if made “under a divorce or separation agreement executed on or before December 31, 2018, even if the agreement was modified after December 31, 2018…” [emphasis added].
One should keep in mind that if you wish to convert deductible/taxable alimony under a pre-January 1, 2019, agreement to non-deductible/non-taxable alimony, the law provides a mechanism to achieve this result (IRC Section 11051(c)(2)).
Further, IRS provides the following guidance in an online posting of IRS Topic No. 452 “Alimony and Separate Maintenance” as follows: “You can’t deduct alimony or separate maintenance made under a divorce or separation agreement,
- Executed after 2018, or
- Executed before 2019 but later modified if the modification expressly states that the repeal of the deduction for alimony payments applies to the modification.” [emphasis added]
Additional informal guidance on modifying pre-2019 alimony agreements is provided in IRS Publication 504 by way of several examples:
- The original divorce decree was executed on January 15, 2014. The decree was modified by the court to increase the monthly alimony payments starting June 1, 2019. The agreement did not expressly state that the post-2018 rules apply, therefore all alimony payments made in 2019 are includible in the recipient’s income and deductible from the payor’s income.
- Assume the same facts as in example 1 above, except the court modified agreement of May 19, 2019, expressly provided that the post 2018 alimony rules apply as of June 1, 2019. In this case the payments made from June 1 forward would not be deductible by the payor nor includible in the recipient’s income.
- Particular care must be taken when modifying a pre-2019 alimony agreement that is temporary. IRS gives us the following example wherein a couple had a temporary alimony agreement going back to 2013. On May 27, 2019, the couple goes back to court and the divorce is finalized with the alimony payment terms identical to what they were under the 2013 temporary agreement. Any alimony payments made after May 27, 2019, are not taxable. Clearly from a tax perspective, this couple would have been better off just continuing to live under the old agreement.
The IRS gives us a final interesting example of a couple who carved out a separate alimony agreement prior to January 1, 2019, yet obtained their final decree of divorce on April 1, 2019. Because the final decree did not mention alimony, and the laws of whatever state the couple resided in allowed the pre-January 1, 2019, separation agreement to survive as a separate contract, the post-2019 payments are includible in the recipient’s income and deductible by the payor because the alimony payments were made under a written separation agreement that was executed on or before December 31, 2018.
Creating the Economic Equivalent of Alimony.
There was much wailing and gnashing of teeth in the tax and family law community with the demise of the alimony deduction for post 2018 instruments. However, often tax deductions are like vampires, they don’t necessarily die, they just come back in a different form. So it is with alimony—at least under the right circumstances. For example, suppose Fred, the high earning spouse, is receiving qualified retirement plan distributions of $10,000 per month. It is decided that Fred’s soon to be former spouse Ethel is to receive alimony payments of $4,000 per month. Suppose Ethel is in the 12% tax bracket and Fred is in the 37% tax bracket. If Fred takes his $10,000 monthly pension distribution and uses $4,000 of it to pay Ethel’s alimony, he will get no tax deduction for the alimony payment to Ethel and after paying tax on the $10,000 he will only have $2,300 remaining ($10,000 x .37 = $3,700 + $4,000 = $7,700) ($10,000 -$7,700 = $2,300).
Now suppose that instead of Fred giving Ethel $4,000 a month in after tax income, Ethel agrees to accept monthly payments from Fred’s retirement plan via a Qualified Domestic Relations Order (QDRO). Since the monthly QDRO distributions will be taxable, Fred incentivizes Ethel to accept the deal by offering her a monthly pay out of $4,780 instead of $4,000. After taxes Ethel will net $4,206 ($4,780 x .88). Which is $206 per month more than she would receive were she to continue with the $4,000 non-taxable payment. Likewise, Fred comes out ahead because he will net $3,288, ($10,000 – $4,780) x 63%, which is $1,288 more per month due to the fact that the alimony payments are now a tax deduction for him.
The net result is that both parties enjoy increased cash flow and Fred receives a significant tax savings especially if the alimony agreement is long term. When the time value of money is taken into consideration, the effect might even be life changing. From Ethel’s perspective, not only is she receiving a higher monthly cash allotment, but she will also have the added piece of mind of knowing that it will be automatically paid from the retirement plan, so she will not have to worry about chasing Fred down to send a check every month.
Another way to create the economic equivalent of alimony, especially early on, is through the tax savvy division of property. For example, suppose Ethel in the 15% capital gain tax bracket and Fred was in the 23.8% (including the net investment income tax of 3.8%) bracket. In lieu of some portion of the alimony payments to Ethel, a greater portion of the capital gain could be allocated to her. Some portion of Fred’s net tax savings could be paid to Ethel in additional cash as an incentive for her to go along with the tax reduction plan.
From Fred’s perspective a situation has been created whereby it is almost the same as if he had received the capital gain proceeds as taxable income, but then in turn paid them over to Ethel as tax deductible alimony. The reason for the use of the word almost instead of exactly is because there would probably be some tax rate differential between the capital gains tax savings verses the alimony deduction, since true alimony is deducted at ordinary income rates which are generally higher than capital gain rates. Alas, nothing is perfect.
 Public Law 115-97, Section (b)(1)(B)
 IRC Section 71(b) Reg. 1.71-1
Have a question? Contact David Ellis, Ellis&Ellis CPAs.
“This article is for informational purposes only and does not constitute tax advice. No advisor/client relationship is created between the author and the reader in the context of the viewing this material.”
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