How to Avoid Paying High Taxes With Alimony
Deciding how to craft a divorce settlement agreement requires more than simply resolving who wants what property and who gets the kids on the weekends. Divorcing parties must take into account all ancillary consequences of any divorce decision, including insurance coverage, retirement accounts, and taxation. Property distributions, alimony, and child support are all treated differently under the tax laws, and different states, as well as the federal government, have different tax rules from one another. Below, our seasoned New Jersey alimony and divorce attorney offers a few tips on how to limit taxes on the alimony you pay or receive.
Federal Rules on Taxing Alimony
For years, the Internal Revenue Service (IRS) treated alimony as follows: Alimony was taxed as income to the recipient and was deductible by the alimony payer. The system encouraged parties to reach a settlement by giving alimony payers tax incentives to agree to higher alimony awards. In late 2017, that system changed.
Under the Tax Cuts and Jobs Act of 2017 (TCJA), signed into law by former President Trump on December 22, 2017, alimony payments are no longer tax-deductible, and alimony recipients no longer have to pay income tax on alimony received. The new taxation rules apply to all divorces finalized on or after January 1, 2019.
New Jersey Rules on Taxing Alimony
New Jersey has not followed the federal government’s changes to the tax laws. Income tax in New Jersey still reflects the rules previously in effect concerning alimony. Parties who receive alimony are subject to state income tax on that alimony, and it is not subject to withholding. Child support payments, in contrast, are not taxable income.
Alimony payers, on the other hand, can take a deduction for alimony paid. Notably, only court-ordered alimony payments are deductible (or payments under a court-endorsed settlement agreement); voluntary payments made outside the divorce judgment or separation agreement are not deductible. Child support payments are not deductible.
How to Maximize Your Alimony Tax Deductions in New Jersey
If you are paying alimony in New Jersey, there are a few things to keep in mind in order to maximize your available deductions. To take advantage of the alimony tax deductions:
- Make sure your payments are ordered by the court as opposed to voluntary. Only alimony paid pursuant to a court order (or court-enforced agreement) is deductible.
- Do not live together or file a joint tax return with your former spouse. Doing either can affect your ability to deduct alimony payments.
- Make sure your alimony payments are separately listed as alimony. Child support and property settlement payments are not subject to tax deductions; intermingling deductible payments with non-deductible payments can hamper your ability to take deductions you are owed.
- Make sure payments are made by money transfer, as opposed to in-kind or property transfers. You can deduct payments made by wire, cash, or check; you probably can’t deduct the value of a car you give to your ex, even if you mean for it to satisfy your alimony payments.
- Don’t pay extra alimony up-front. Pay in accordance with your monthly requirements, rather than trying to take extra deductions in the early years.
Alternatives to Alimony
There are alternative arrangements that the parties can pursue to get around the federal and state tax schemes concerning alimony. For example, the parties can set up a trust that will grow over time and distribute payments to the party who would have received alimony. The income disbursed by the trust would be taxed as income to the recipient, more like the old taxation scheme prior to the TCJA. The trust can be set up as part of a property settlement in the divorce.
Alternatively, if the parties are trying to avoid New Jersey’s income tax scheme, the parties can agree to a lump-sum payment as part of the property settlement instead of ongoing alimony payments. The property settlement is not tax-deductible for the payer and is not taxable to the recipient. Talk to your divorce and property settlement attorney about your circumstances to explore your options.
Trusted Advice and Representation for Your New Jersey Alimony/Spousal Support Matter
If you need effective legal help with alimony, child custody, child visitation, premarital agreements, child support, or other family law matters in New Jersey, contact the Union offices of family law attorney John B. D’Alessandro at 908-964-0102.