Tax Implications of Alimony in Wisconsin

Updates to the Law – What Are The New Rules?

In 2017, sweeping tax reform laws were passed. Some of those changes have taken longer than others to go into effect. If your divorce settlement happened before 2019, then these changes will not affect you unless you specifically request to modify it.

Under the old law, alimony was considered taxable income by the person receiving it and could be deducted by the person paying it. This put the biggest tax burden on the person receiving the alimony. The new law flips that.

Now, the spouse paying alimony must pay income taxes on it, and the person receiving it does not pay taxes on it and cannot claim it as income.

Examples of Alimony Payment – New Law and Old

The tax implications of alimony payments can be confusing. So to help, here are examples using both the new and the old law.

In the divorce settlement, John was ordered to pay alimony to his wife, Susan. John earns $350,000 a year and Susan is a stay-at-home parent. John is ordered to pay $75,000 in alimony per year.

Note: Our examples use the 2020 tax bracket. Tax brackets are updated every year by the IRS, so the actual figures may vary.

The New Law – Marriages Settled After Jan. 1, 2019

In the new law, John is liable to pay income tax on the $75,000 alimony payment. Because John’s annual income of $350,000 puts him in the 35% tax bracket, he would have to pay an estimated $26,250 in taxes (see the tax bracket section below). He cannot deduct this from his income.

When Susan receives the $75,000 alimony payment, she does not have to pay income tax on it.

2020 Tax Brackets

The Old Law – Marriages Settled Before 2019

In the old law, John pays $75,000 to Susan and deducts that amount from this income. Susan declares the $75,000 as income on her tax return.

Because that is the only income she earned, that puts Susan in the 22% income bracket (see the highlighted section in blue below). Therefore, Susan pays 22% ($16,500) in taxes.

2020 Tax Brackets

Are the Changes to the Tax Law Retroactive?

The new law is not retroactive and only affects divorce agreements that were settled after 2019. Alimony payments from a divorce before that point are under the same rules as before.

The new rules can be applied to existing alimony payments if it’s specifically included in an alimony modification. It’s important to note that modifying an alimony payment does not automatically make it subject to the new rules. So, if it’s in your best interest to apply the new rules, you must specifically request that language be included.

A Note on Retirement Savings Under the New Law

If you are receiving alimony under the new rules, there’s one additional thing to consider. Under the updated tax laws, you can no longer use alimony payments to contribute to a retirement account.

This is because only taxable income^[1] can be used in an IRA or 401(k). Because the new law makes alimony payments tax-free, you may have to consider other options for retirement savings.