Change Is Coming, Tax Reform Act Punishes Divorcing Couples

January 1, 2018
Written by Lynne C. Halem

The Way It Was: A Bit of Alimony History

The passage of The Revenue Act of 1942 revolutionized alimony law. After decades of debate, the financial impact of divorce was redefined as the paying party (known as the “payor”) became entitled to deduct alimony from his/her income, while the recipient party (known as the “payee”) took the payments as income.

Given the complexity of our tax code, it is not surprising that numerous refinements were introduced over time.   Restrictions were devised to minimize “trickery,” attempts to circumvent the intent of the law by disguising property settlements and child support payments as alimony. Other modifications proved more advantageous to the divorcing population, opening new opportunities to incorporate tax-planning options into the structuring of family support terms. The end result was to provide more money to the post-divorce family, thereby somewhat easing the negative financial impact of divorce.

The Way It Will Be: Changes to Alimony Taxation

Over seven decades later, at the tail end of 2017, Congress passed a new tax bill that suggests, in word and in deed, that divorcing couples have been taking money from the government by shifting the taxability of income from the higher income spouse to the lower income spouse.  The new act aims to prevent this “nefarious” practice, often labeled as a divorce subsidy, by rendering alimony payments as after tax income, beginning with the 2019 tax year.

Thus for couples divorcing in 2019 and, for modifications of pre-2019 divorces, if there is an election to follow the new law, alimony “payors” will not be eligible to deduct his/her payments and, following logically, recipients spouses will not pay taxes on payments received by them.

Consider the difference:

• Under 2017 tax law, if the “payor” party, earned $200,000 and made an alimony payment of, say, $45,000 to a former spouse, he or she would have been able to take a deduction from income of $45,000. Based on a gross estimate of tax savings, the higher earning party would save about $13,500.  The recipient spouse, in a lower tax bracket, would be required to pay taxes on the same $45,000, paying perhaps about $10,000. It is precisely this shifting of taxability that created the means, and indeed the bargaining tool, to motivate the higher income spouse to pay more alimony to the lower income spouse.
• As of 2019, based on the new tax law, the “payor” party will pay taxes on his/her entire $200,000 of income with no credit for the payment of $45,000.  Conversely the recipient spouse, with an income of say $50,000 and alimony of $45,000, will pay taxes only on his or her earned income of $50,000.
• In the main the new tax law’s impact on divorcing couples has been ignored.  Nary a commentator, other than divorce lawyers and their associations, has spoken of the law’s momentous change for the divorcing population. Although much chatter has been expended, analyzing the negative impact of the law on numerous populations, the 2019 “to-be divorced” population has been virtually overlooked.

Advocates of the 2017 tax law are quick to put forth arguments to bolster their position and, in particular, their depiction of the divorcing population as a new revenue source aimed at deficit reduction.

• No more free money for divorcing, high earners
• Protection for lower income spouses who will not have to pay taxes on their alimony
• Removal of the financial incentive for divorce

In the real world, there are few individuals who truly believe that the tax deductibility of alimony provides an incentive for divorcing.  Nor are there many who think that divorce is nothing but a money deal, that there are no emotional and painful components existing quite apart from thoughts on “making a buck on the deal.”

And, too, we cannot, in good conscience, ignore the fallacious reasoning underlying the “doing-a-good-deed” argument, which claims that lower income spouses, receiving tax-free support, will be the real beneficiaries of this new law. This conclusion demonstrates not only an ignorance of alimony laws, but especially of the “art” of negotiation.  In truth, if the higher income party has less money to pay, there will be negative financial consequences for the whole family.

Consider for the moment in Massachusetts, the 2011 Act Reforming Alimony, which law went into effect in March 2012. This law provides a formula for the calculation of alimony based on 30 to 35 percent of the difference between the parties’ gross incomes or the recipient’s need.  Obviously these percentages were not arbitrarily derived. To the contrary, they were based on analyses of tax implications under long- standing tax law rendering alimony as a deduction to the “payor” and as taxable income to the recipient.  Clearly in the new 2019 world of divorce these operating percentages will require modification. The calculus no longer works.

We can certainly expect to see a flurry of activity in 2018, with separating couples, who are considering alimony in their deliberations, speeding up the process in order to benefit from financial incentives related to the pre-2019 tax characterization of alimony.  Did someone say that the new law provided a disincentive for divorce?  I would guess not to those in 2018 who are considering alimony payments.

And what about the existing laws throughout the United States?  It does not take much imagination to assume that current support laws will now be the subject of renewed interest. Predictably legislators of all persuasions will rush to submit proposals dealing not only with the impact of new tax distinctions, but also seeing an opportunity to enact their own agendas for change.  The resultant alimony law for our post-2018 Massachusetts’ world is anyone’s guess.

At CMDR we suggest that, at the very least, the problem solving nature of the mediation process offers divorcing couples the opportunity to shape their own agreement now or in 2019. Weighing tax implications and the financial impact on all family members should certainly play a role in the negotiation process, but so too should the resulting impact on the well being of all family members.