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Alimony IRA contributions subject to ‘old’ rules

Jim HamillALBUQUERQUE, N.M. — Q: I was divorced in 2016 and I receive alimony from my former husband. I have always made IRA contributions from the alimony income and I was advised that this is proper. Will I be able to continue to do this when the new tax law changes the treatment of alimony, which I think happens in 2019?

A: Yes you will. Because your divorce was completed before 2019 you will continue to be subject to the “old” rules for alimony payments. This means that you will continue to be taxed on receipt of the payments and your ex-husband will continue to claim a deduction.

The “old” law, which really is still the current law because the new law applies only to post-2018 divorce agreements, treats alimony received as earned income for purposes of contributions to an IRA. This treatment continues to apply to you forever based on the pre-2019 date of your divorce.

There is one exception that could apply. If your divorce instrument is modified after 2018, and that modification says that you and your ex-husband intend to change the tax treatment of the alimony, then you would be bound by that modified agreement.

But a modification alone will not change the tax treatment of your alimony. You will still need to agree that the modified agreement will be subject to the new law treatment for post-2018 alimony.

Q: I am a shareholder in an S corporation that has substantial losses over the past three years. I also have income from investments that I have been able to avoid paying tax on because of the business losses. Our controller has advised us that beginning in 2018, the losses from the business are limited to $250,000 per year. This limit could cause me to pay tax on investment income when I have overall losses from all of my activities. As an example, if I have $400,000 of investment income and $400,000 of business losses I paid no tax in 2017, but I am now being told that I could end up paying tax on a net $150,000 because the business loss is limited. Is this correct?

A: It probably is, but it depends on your specific situation. First, under pre-2018 law your explanation of the tax result (no net income and no net tax) depends on you materially participating in the activities of the corporation.

If you did not materially participate in the business, your pre-2018 $400,000 loss would be suspended under the passive loss rules. You would then have income of $400,000 and no allowed loss to offset that income.

Your example then is correct if you do materially participate (this is an annual determination). Then, beginning in 2018, the law has changed to limit the annual loss from business operations to $250,000.

For a married taxpayer filing a joint tax return, the loss limit is $500,000 per year. Any loss disallowed under this limitation is treated as a net operating loss to be carried to the next tax year (again subject to the overall $250,000 limitation).

For a taxpayer with a business loss suspended under the passive loss rules (because he or she does not materially participate in the business activity), the loss will first be limited by the passive loss rules before the $250,000 annual limit is applied.

Your example is then correct, assuming you materially participate in 2018. You will have no net income in an economic sense, but the tax law will limit the business loss to $250,000 and you will have net income of $150,000 subject to tax.

You, of course, still get the standard deduction or itemized deductions in the same manner as any other taxpayer, but the example was a simplified one and does correctly interpret the law.

The disallowed loss, $150,000 in your example, is not lost forever because it will carry forward to the next tax year(s) and will be available under the same $250,000 overall limit.

This $250,000 limit applies to net business income reported on the tax return. So, if you have income from another business activity that income could be sheltered by the business loss. Investment income cannot be sheltered with an excess business loss.

Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

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