Expiration of Trump tax cuts complicates alimony agreements

The looming expiration of some aspects of the 2017 Trump tax cuts complicates alimony agreements for small-business owners and residents of high-tax states.

Discussion of the signature piece of legislation from President Donald Trump's first term often focuses on its cuts for high-income earners and corporations and the increase in the standard deduction.

But it also made a simple change that had a significant impact. Under the law, alimony agreements finalized after Dec. 31, 2018, no longer qualify for tax deductions. Instead, under the revised text of 26 U.S. Code § 71, they are treated as a personal expense.

This was great for recipients, who no longer have to report alimony as taxable income. But it complicated things for people paying alimony, who can no longer deduct it as an expense.

Two other changes made that even more complicated for small-business owners and residents of high-tax states such as California, especially as both are set to expire in 2025: 

• The state and local tax deduction: The law capped the federal deduction for paying state and local income tax (or SALT) at $10,000 a year.

• The qualified business income deduction: The law also gave small business owners a 20% deduction on certain income.

The SALT cap means that some higher-income residents of blue states were hit with much bigger tax bills. But, as noted in Section 11045 of Public Law 115-97, it is set to expire after 2025. If it expires this year as planned, some wealthy people paying alimony will have more disposable income, which could lead their former spouses to go to court to seek more alimony.

On the flip side, the end of the qualified business income deduction -- found in Section 11011 of the tax cuts law - could mean that some small business owners will suddenly have a much bigger tax bill, which could make it harder for them to make their current alimony payments.

To make things more complicated, Republicans in Congress are already looking to pass another major tax cut bill under Trump, but with narrow margins in the House and Senate negotiations will be extremely difficult.

While it is expected that Republicans will unite to pass some form of tax cut, it remains difficult to predict its specific details.

Republicans who represent blue states, especially in the House, have been pushing for an end to the SALT cap, and small business owners are also lobbying for the qualified business income deduction to be extended. But both would raise the cost of the bill.

Couples currently going through divorce should proceed as if both the cap and the deduction will expire, understanding that if the tax law significantly changes their former spouse's financial situation, the agreement may need to be updated.

If seeking to modify a spousal support agreement signed on or before December 31, 2018, you have a choice regarding tax law.

Simply modifying the agreement won't automatically change the tax reporting requirements, but you can explicitly state that they will if both parties agree. For agreements signed after 2018, you generally are going to have to stick with the new tax rules.

For residents of California, there's one additional complication. When filing your state taxes, the rules for deductions remain the same as the old federal rules: payers can deduct alimony, while recipients must report it as income.

That can complicate tax filing for many Californians who need to maintain separate records for their state taxes from their federal ones.

As tax season approaches, it's important to be aware of these rules, but if you face any thorny questions when preparing your taxes, you should consult with your family law attorney and possibly a tax accountant as well.