Spousal support taxability is important. The huge change to tax law passed under the President Donald Trump administration in late 2017 had many huge impacts, one of which was for the taxability of spousal support. (The IRS and some other states call it “alimony” but in California we call it “spousal support.)
It is important to understand what the law used to allow. The old federal tax law allowed those paying support to deduct the support payments from their taxes, and the person receiving it would include it as taxable income. Since the person paying it got a tax deduction, that freed up income and in most instances support would be a little bit higher.
With the new law, starting 1/1/2018, the person paying spousal support does not get any tax deduction, and the person receiving spousal support gets it tax free. The policy reason behind this change was one of perceived fairness: why should divorcing couples get a tax benefit (the deductability of spousal support) that the rest of taxpayers do not get?
Lets put this into contact with a couple hypotheticals:
HYPOTHETICAL 1 under the old federal tax law: P1 makes $100,000 per year and pays $20,000 per year in spousal support to P2. By paying support, the taxable income is $80,000 and because P1 is getting taxed at a lower amount and saves some in taxes it feels like paying $17,000. P2 gets the $20,000 but owes taxes on it so after paying taxes the net result of $18,500.
HYPOTHETICAL 2 under the new federal tax law: P1 makes $10,000 per year and pays $18,000 in spousal support. P1 does not get a tax deduction. P2 gets $18,000 in spousal support tax free.
When comparing the two hypotheticals, you can see that from P1’s perspective, support went from feeling like paying $17,000 (after the tax benefit) to paying $18,000 so more was paid. From P2’s perspective, support went down from a net after taxes of $18,500 to $18,000 tax free. Both sides are worse off compared to the old tax law.
A few years ago, I attended a continuing education program with divorce financial expert Kenny Pierce. Mr. Pierce ran 200 support calculations and put them in Excel spreadsheets so we could see the difference in the tax law changes. 100 calculations were under the old law, and 100 were under the new law. Each of the 100 calculations changed the income by $1,000. What you could see from the data was, unless the two sides made about the same in income, they were better off under the old tax law. When there was a disparity of income, as is the case in many divorces, the couples are worse off financially when it comes to spousal support.
Whether you are paying spousal support, or receiving it, a spousal support order can make a huge difference in your life. Getting proper legal advice is important. Paying for an attorney can be well worth it when support is continuing over many months. James Moore is licensed in California and routinely handles family law cases and support issues in Placer County, Nevada County, the greater Sacramento area.