People in the business sometimes joke that alimony is the last tax shelter. Each dollar of alimony paid is subsidized by an absolute dollar-for-dollar adjustment to income, which at the top federal bracket saves the payer 35 cents. The tax burden then shifts to the payee, who pays taxes on alimony received, at his or her blended tax rate. For a $100,000.00 per year alimony recipient, if he/she has no other tax deductions (not very common), blended federal taxes total about 20%. Thus, the government loses 15 cents per alimony dollar. (At lower alimony levels, the payee’s tax rate drops and the treasury's proportionate loss increases.)
That brings us to the dreaded Fiscal Cliff, where tax rates and tax “reform” dominate the public discourse. By all media reports, increased tax rates for the “top 2%” are all but inevitable, while reform is also in the wind, now or shortly later. Reform seems likely to include at least some limitations (read, reductions) of itemized deductions such as home interest, local taxes paid and employer provided health care.
Yet, with all the talk of cutting tax preferences, we have not heard a word about any threat to the alimony deduction. Could this be because alimony payers are a formidable interest group? Is it that too many Congressmen pay alimony? Is it that alimony dollars are taxable to someone – the recipient? Maybe, the cost to the treasury is not great enough to garner attention. Whatever the reason, the alimony deduction, like the near-sacred charitable deduction, seems safe.
In fact, it looks like the value of the alimony tax deduction will increase in 2013 since, as the tax rates of alimony payers increase, so too will their alimony subsidy. If the top bracket resumes its Clinton Era 39.6% level, the value of the deduction for the high income earner will increase commensurately: a 13.1% increase! Where else do we find a tax shelter of increasing value in Fiscal Cliff America?