Divorce negotiations are set to heat up even more than usual now that the new Tax Cuts and Jobs Act has passed into law. That’s because the law changes the rules regarding how alimony payments are taxed. Here’s an overview of what all of this means for divorces going forward.
Settling the terms of a divorce is a nerve-racking ordeal for both parties. If the divorcing couple has kids, figuring out custody, schooling, visitation rights and child support is emotionally trying, terribly complicated and largely dependent on differing state laws. Dividing up property like homes and cars can be tricky as well. Underlying all this stress is the prospect of ongoing financial burdens for both parties. It’s always more expensive for a family to live split apart than to stay together because living expenses are essentially doubled. And when kids are involved and separated by long distances, the family will incur travel and lodging costs for each visitation.
For the last 75 years, the IRS has provided one instrument to help ameliorate the financial strain placed on divorcing couples: Payers of alimony could deduct those expenses when filing their federal taxes. Alimony is the court-ordered arrangement for the higher earner to pay the lower-earning spouse for a certain term, and negotiating the amount to be paid is a big part of typical divorce proceedings. Since alimony payments could be written off, the amount of that deduction has also figured into negotiations. The alimony deduction gave attorneys on both sides a valuable tool — for recouping some money for the payer on one side, and getting a higher settlement for the other because of those savings.
Also for the last 75 years, the recipient of alimony has been required to file that money as income and pay the requisite taxes on it. However, two factors usually more than compensate for that cost. First, as the lower-earning spouse, the recipient is probably in a lower tax bracket and won’t incur a very high rate on alimony income. Second, as mentioned above, the deduction available to the payer figures into negotiations, resulting in a higher settlement.
Here’s an example. Spouse A is federally taxed at 33% and is ordered to pay $30,000 in alimony to Spouse B, who is in a 15% tax bracket. Spouse A saves $9,900 by deducting the payments, paying only $20,100. Spouse B must pay taxes on the $30,000 received, but at the 15% rate, which comes to $4,500, resulting in a total received amount of $25,500. Between the two of them, $5,400 has been saved, coming from the IRS, and Spouse A has been able to pay an extra $9,900 at no cost.
But this is coming to an end. For divorces that commence on or after January 1, 2019, payers of alimony will no longer be able to deduct it on their federal taxes, nor will recipients be required to file it as income. To revisit the example case, that means Spouse A would need to pay $30,000 rather than $20,100, and Spouse B would keep the full amount of $30,000 rather than $25,500.
At first blush, this would seem to benefit the alimony recipient, which was a point used in political discussions over the new law. Statistically speaking, the recipient is almost always the woman. Recent statistics are difficult to find because the U.S. Census Bureau no longer asks about alimony, but the 2010 census showed that 97% of alimony recipients were women. This trend is slowly changing, however, as women earn increased wages, but it stands to be highly imbalanced for some time to come.
Remember, however, that the alimony deduction has always figured highly into settlement negotiations. In fact, the software that courts use to calculate these numbers takes the deduction into account, and that software will soon be useless. So, to return to the example case one more time, let’s consider how negotiations would go in 2019 under the new law.
Spouse A, who would have been ordered to pay $30,000 in previous years based on the knowledge that a write off would save $9,900, instead negotiates to pay the $20,100 because the deduction in gone in 2019. Spouse B, who would have had to pay taxes on the received amount in previous years, now gets the full amount in 2019. Unfortunately, that full amount is now only $20,100, compared to the net of $25,500 before. Between the two of them, they’ve saved $0 based on the new tax rules, and Spouse B has received $5,400 less than before.
The new alimony rules are complicating an already messy process, and as shown, the change could result in more financial strain. Anyone considering a divorce should consult a qualified attorney and discuss this matter. “A good family law attorney will listen and help you understand tough issues and changing laws,” says Sherry Cross, a family law attorney in LA.
Keep in mind that the new tax rules do not affect any existing alimony agreements. To be clear, the new law only applies to divorces commenced on or after January 1, 2019, or any agreements modified after that time to explicitly follow the new law. Seeing this change on the horizon, some divorcing couples may feel compelled to put a rush on it to save themselves some money.
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