IMPORTANT UPDATE: Effective starting in tax year 2022, alimony is no longer deductible for Massachusetts state income tax purposes. To read more about this rule change, click here.
This blog has spent considerable time reflecting on the impact of the Tax Cuts and Jobs Act (“TCJA”) on family law. In addition to making significant changes to child tax credits/exemptions, the TCJA has somewhat notoriously eliminated tax deductible alimony for former spouses who finalized their divorces after January 1, 2019. Somewhat lost in the consternation over the loss of federal tax deductibility for alimony is the fact that alimony remains tax deductible for state income tax purposes in Massachusetts and some other states. The continuing deductibility of alimony for state income tax purposes represents an important detail for divorcing spouses, judges and attorneys to consider when reviewing and preparing separation agreements and orders for alimony.
Massachusetts Lawyers Weekly: Alimony Still Tax Deductible on MA State Income Taxes
We recently blogged about the increasing calls to update the Massachusetts Alimony Reform Act (ARA), where the ARA’s formula for calculating alimony was based on the assumption that alimony is always tax deductible for federal income tax purposes:
Under the ARA, alimony is presumptively capped at 30 to 35% of the difference between former spouses’ respective incomes. However, the 35% cap was based on the historically reliable assumption that alimony payments would always be tax deductible to the paying party.
The Tax Cuts and Jobs Act (TCJA) of 2018 eliminated tax-deductible alimony for new divorces starting on January 1, 2019. Following a scramble in the final months of 2018 to enter agreements for alimony that preserve tax-deductibility, the new reality is setting in, and the math isn’t pretty.
That blog referred to a Massachusetts Lawyer’s Weekly article (subscription required) that explained the proposed changes to the ARA. The Lawyers Weekly piece confirmed what we predicted last year, noting “that Massachusetts is continuing to allow payors to deduct alimony from their state income taxes”.
Why Is Alimony Tax Deductible for Massachusetts State Income Tax Purposes?
Anyone who has prepared their own tax return has likely realized that Massachusetts state income taxes include many of the terms, concepts and specific items set forth in the federal Internal Revenue Code (IRC). There are important differences between state and federal tax law, however, particularly in Massachusetts.
In 1998, Massachusetts adopted the Chapter 319 of the Acts of 1998. This law provided Massachusetts independence from many parts of the federal tax code:
As a general rule, Massachusetts will not adopt any federal tax law changes incorporated into the Code after January 1, 1998. However, certain specific provisions of the personal income tax automatically adopt the current Code. These include (i) Roth IRAs, (ii) Education IRAs, (iii) the exclusion for gain on the sale of a principal residence, (iv) trade or business expenses, (v) travel expenses, (vi) meals and entertainment expenses and (vii) the maximum deferral amount of government employees' deferred compensation plans. As explained in TIR 98-8, Massachusetts will adopt all future federal tax law changes affecting these provisions.
Each year, the Massachusetts Department of Revenue issues a “technical information release” that explains which changes to the federal tax code that Massachusetts plans to adopt for state income tax purposes. For example, in 2018, TIR 98-15 announced that Massachusetts announced a series of federal tax exclusions, credits and payments that Massachusetts was either adopting as part of its state tax code or declining to follow.
Massachusetts is not alone in making alimony tax deductible for state income tax purposes. Largely in response to the TCJA, the New York legislature passed a new state tax scheme for the tax deductibility of alimony in New York for state income tax purposes. The notoriously slow-moving Massachusetts legislature may not follow suit with a comprehensive bill, but for the time being, alimony remains deductible for Massachusetts state income tax purposes courtesy of Chapter 319 of the Acts of 1998.
How Big an Impact Does Continuing Tax Deductibility of Alimony Have on State Income Taxes?
The Massachusetts state income tax rate for 2019 is 5.05% of each tax payer’s gross income. In rough terms, this means that after exemptions and other deductions have been applied, every $100,000 earned by a taxpayer generates Massachusetts state taxes of $5,050. If said taxpayer pays alimony of $20,000 per year from this hypothetical $100,000 in gross income, the deductibility of alimony from his or her state income taxes would generate tax savings of approximately $252.50 (i.e. 5.05% of $20,000).
In comparison, the 2019 federal tax bracket for individual’s earnings gross income between $84,200 and $168,400 is 24%. For an individual with $100,000 in taxable income and $20,000 in annual alimony payments, the loss of federal tax deductibility results in additional tax exposure of roughly $4,800 (i.e. 24% of 20,000).
In short, the loss of federal tax deductibility of alimony is more than 15 times greater than the deductibility of alimony for state income tax purposes.
Will Alimony be (Federally) Tax Deductible for Massachusetts Residents Divorced in the Final Months of 2018?
It is important to remember that the TCJA preserved federal tax deductibility for individuals who finalized their divorce before 2019. In Massachusetts, the existence of the arcane and pointless “nisi rule” has created ambiguity over whether alimony will be tax deductible for individuals who were divorced in the last four months of 2018.
Since we blogged about the nisi issue last summer, several arguments have been made for and against the federal tax deductibility of alimony for divorces entered during the nisi period in the final months of 2018. Jonathan Fields, a highly regarded Boston attorney, argued in Massachusetts Lawyers Weekly (subscription required) that alimony payments arising out of divorce agreements entered during the nisi period in late 2018 should be deductible for federal income tax purposes, where existing federal tax law precedent favored alimony being deductibility based on the date an agreement was signed – rather than the date a divorce becomes “final” under the “nisi rule.” However, Fields concluded his persuasive argument by admitting:
In the months ahead, while many labor to complete agreements by year’s end, we can hope for clarifying guidance from the IRS. In the meantime, especially in the gray areas, practitioners would do well to let clients know, in writing, where there are uncertainties as to whether their agreements will be grandfathered.
A less optimistic tone was struck by the widely respected Boston mediator, William Levine, who wrote in Lawyers Weekly (subscription required) that the federal political considerations could impact interpretations of the TCJA’s alimony provisions, making the historical precedents cited by Fields less reliable:
[T]he Trump administration has incentive, especially in an election year during which the deficit is rising faster than projected, to interpret the alimony repeal in a way that maximizes revenues to offset some of the TCJA’s corporate and high-income tax cuts.
As this blog noted, the confusion surrounding alimony deductibility in late 2018 presented the perfect opportunity for the Massachusetts legislature to eliminate the ancient and confusing “nisi rule” completely. Eliminating the nisi period would have avoided both the specific confusion surrounding alimony deductibility in late 2018, and the far broader everyday confusion created by the “nisi rule” in Massachusetts, where divorced spouses puzzle over exactly what the judge meant when he or she said, “your divorce will be final in 90 days.”
Of course, this never happened. As Lawyers Weekly recently noted, Massachusetts remains the only state in the US that has failed to pass the Uniform Child Custody Jurisdiction and Enforcement Act (passed in 49 other states). If there is one thing that legislature loves, it is leaving stupid, outdated laws on the books long after they stopped being enforced.