Currently, spousal support — also known as “alimony” — payments are typically tax-deductible to the payor. Specifically, the payor of spousal support deducts the spousal support payment on his or her tax return, which reduces taxes paid. On the other hand, the receiver of spousal support claims spousal support on his or her tax return, which increases taxes paid. However, a bill was recently proposed in the House of Representatives that would eliminate tax-deductibility of spousal support. This sounds like it will help the receiver of spousal support since he or she would not pay any taxes on spousal support, right? Maybe not.
Let’s say Husband was ordered to pay Wife $1,000 a month in spousal support. Let’s also say that Husband’s income is higher than Wife’s and that his tax bracket is 25%. This means that Husband is actually paying Wife $750 per month because he gets to reduce his taxes by $250 (i.e., $,1,000 x .25). On the other hand, let’s say Wife’s tax bracket is only 15%. Wife, then, actually receives $850 because she has to pay taxes of $150 per month (i.e., $1,000 x .15).
However, if tax-deductibility of spousal support is removed, this shifts all of the tax burden to the payor spouse. In our example above, this would mean that Husband would pay the government $250, instead of Wife paying the government $150. This will also increase the financial hardship on the paying spouse, possibly requiring a reduction in spousal support to a more affordable amount, which may be financially worse for the receiving spouse.
There are additional complications: Since the proposed law only deals with Federal taxes, California may not follow suit for state tax purposes, potentially making tax filing more complex. Also, the effective date for this new law is January 1, 2018, and it appears that the new law would apply to cases where a judgment was not entered on or before December 31, 2017. This means that couples currently undergoing a separation should potentially re-examine spousal support where tax-deductibility was a consideration. Another option is to attempt to get your judgment entered before December 31, 2017!
While this may become law in the future, as Schoolhouse Rock would say: “But today, I am still just a bill.”