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Tax reform could shrink alimony for former spouses

CNBC logo CNBC 11/5/2017 Sarah O'Brien

Alimony payments mandated by divorce agreements could lose their beneficial tax treatment.

The Tax Cuts and Jobs Act, unveiled on Thursday, includes a provision to kill the deduction that divorcees get for such payments to an ex-spouse. Although it's just one of the many tax breaks eliminated under the legislation, experts say it will end up most hurting the person receiving the money.

"Alimony payers won't be able to afford to give as much because they'll have to give it to Uncle Sam instead," said Nancy Hetrick, a certified divorce financial analyst and senior advisor at Better Money Decisions in Phoenix, Arizona. "There will be less money to go around to support the two households."

If the deduction disappears, it would affect divorce agreements — where the amount and duration of alimony is codified — entered into after 2017. Child support, which is separate from alimony, already offers no deduction.

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Alimony, also known as spousal support, is often part of divorce agreements when there's a big discrepancy in earnings between the two parties and the marriage has endured for more than a few years.

In 2015, according to the data from the Internal Revenue Service, an estimated 598,888 taxpayers claimed the alimony deduction on their Form 1040, for a total of more than $12.3 billion.

However, the deduction has been a trouble spot for the IRS.

Under current law, the person paying the alimony deducts the amount and the recipient claims it as income and pays taxes on it. A 2014 Treasury report found a large discrepancy in those amounts.

More than a half-million taxpayers claimed alimony deductions totaling more than $10 billion in 2010, according to the report. Yet on the other side, recipients' reporting of alimony income was $2.3 billion less.

The new tax legislation essentially would shift taxation from the recipient to the alimony payer.

"Due to the disparity in tax rates that exist in these cases, this would have a negative effect on the payee. That's the bottom line," said Malcolm Taub, co-chair of Davidoff Hutcher & Citron's Divorce & Family Law Group in New York.

Because the ex-spouse receiving the alimony typically is in a lower tax bracket, the amount of tax paid by the recipients — the majority of which are women — on the spousal support is less. And it's something that courts, attorneys and divorce planners take into consideration when divvying up assets.

For illustrative purposes: Say the ex-husband is paying $3,000 in monthly alimony and is taxed at 33 percent. In effect, the deduction at tax time reduces each of those payments to $2,000.

On the receiving end, say the ex-wife is in the 15 percent bracket. The $3,000 she receives is reduced by $450, which goes to taxes, leaving her with $2,550.

Under the proposed change, providing the ex-wife with the same level of support would cost the ex-husband $2,550 instead of $2,000.

"I don't think courts could award the same amount, given that it wouldn't be deductible," Taub said. "There's only a limited amount of dollars in the pot."

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