You may have heard that alimony payments under newly executed divorce arrangements are no longer deductible for federal income tax purposes. This longtime deduction, which had been in place for about 75 years, was eliminated through one of the most controversial and well-publicized provisions of the Tax Cuts and Jobs Act of 2017.
With so much attention focused on loss of the federal deduction, there’s a related consideration that has received very little attention: alimony that is no longer deductible federally may still be deductible for state income tax purposes. This can be a very important point for couples seeking a divorce, especially in high-tax jurisdictions where the state tax deduction has higher value.
Federal alimony deduction used to be top consideration
The federal alimony deduction had been a longtime staple in divorce planning. The old rule allowed the alimony payer to deduct his or her payments while the recipient paid income tax on any alimony received. The result enabled separating couples the opportunity to shift taxable income from the spouse earning more income to the one earning less. In cases where alimony was substantial, this tax treatment afforded the two individuals a valuable opportunity to save on their aggregate federal income tax bills.
The deduction also took some of the sting away from the ex-spouse who was paying the alimony. These potential benefits gave divorcing couples the ability to help defray some of the high costs of divorce, putting the alimony deduction at the center of divorce negotiations and among the top considerations by legal decision-makers.
Changes under the new law
The Tax Cuts and Jobs Act of 2017 eliminated the federal alimony deduction for any alimony paid under divorce agreements executed after Dec. 31, 2018. Additionally, previously executed divorce agreements may become subject to the new rule if an alimony modification agreement specifically states that the new law applies.
So, how do divorcing couples know if alimony is still deductible on their state tax return? It depends on whether and how your state follows the federal tax rules. This can get complicated, but generally, there are three ways:
1. They apply the federal definitions of adjusted gross income or taxable income: Most states — but not all — use your federal adjusted gross income as the starting point for determining state taxable income. The federal alimony deduction reduced the payer’s federal adjusted gross income. With the repeal of this deduction, if your state strictly follows the federal rules, then you would effectively lose the alimony deduction on your state income tax return as well. A similar effect can occur for those states whose starting point is federal taxable income, a derivative of federal adjusted gross income.
2. They follow the federal tax provisions but only as of a certain date: When this is the case, you would want to check how the state times its conformity to the federal laws. For example, if you live in a state that last conformed before the federal law changed, then the alimony deduction might still be available at the state level. Some of these states, including California and Massachusetts, have already clarified that the alimony deduction will remain in place.
By the way, if you live in Alabama, Arkansas, Mississippi, New Jersey or Pennsylvania, you’ll have to check the rules even more carefully because these states only selectively conform to the federal income tax structure.
3. They diverge from the federal tax provisions: Despite all of the above points, states are always free to enact their own state tax legislation. Of course, AK, FL, NV, SD, TX, WA, and WY do not impose state income taxes, and NH and TN impose income taxes only on certain types of income. In the world of taxation, there are always intricacies and exceptions; but in the world of state taxation, there are even more.
What it means for you
Despite the loss of the federal alimony deduction, a state deduction may still be available. For couples with prenuptial and postnuptial agreements, the potential impact of the law change remains to be seen. Considering that these agreements may have established alimony payments assuming the old tax treatment, the federal tax law change may have implications even for currently married individuals.
In simple terms, alimony planning may have become less important from a federal income tax perspective, but it can still be quite important from a state and local income tax perspective. In a sense, the repeal of the federal deduction may actually cause some to overlook the tax angle altogether — a trap for the unwary in states and localities that still offer the deduction. Because of the complexity of state tax laws, we recommend that you consult with a financial adviser, attorney, or accountant to see how this new law may affect you.
Michael J. Nathanson, JD, LLM, is Chairman and CEO and Dawn Doebler, CPA, CFP®, CDFA® is a senior wealth adviser at The Colony Group. Dawn is also one of the founders of Her Wealth®.