Tax Bill Impacts Divorce

The GOP tax bill signed by Trump late last year changed drastically how maintenance/alimony will be handled.

One way the Republican tax bill writers tried to raise revenue to compensate for the cuts was through maintenance/alimony. Under the new bill, alimony paid by one spouse to the other will not be tax deductible, and the spouse receiving the alimony no longer has to pay taxes on it. In the current system, it works the opposite way, with the payer deducting the full amount and the recipient paying taxes on the alimony at a rate of 15%. The new rule means the government will end up with more of a divorcing pair’s combined money.

Although the law won’t take effect until next year, giving divorcing couples a reprieve for now divorces are potentially likely to get a lot messier.

Amicable divorces will become more difficult now that the maintenance/alimony payer is not only going to have to pay but will lose a key deduction, thus suffering a much higher financial burden.  This will likely make settling more of a challenge and cause more tension and fights among parties and lawyers.

Perhaps the largest and most uncomfortable tension will stem from timing. One side could be dragging its feet in an attempt to delay, and the other will be trying to get a deal signed before New Year’s.

New York has a formula for calculating appropriate payments and less leeway for negotiations, so timing may be critical.

The loss is not only for the monied or paying spouse. If the courts start adjusting the maintenance to compensate for this tax change the spouse receiving the funds could loose out as well.

An example of the change

Using a wealthy client as an example, under the old system, if a highest-tax bracket, soon-to-be ex-spouse was set to pay $100,000 per year in alimony, they would get a deduction off the top — at the highest tax rate of around 40% — so they would only be out around $60,000. The recipient would end up with $85,000 after paying a 15% rate on that $100,000.

For couples divorcing in 2019, if the wealthier spouse paid $60,000 — the same out-of-pocket cost as the example above (they’d have less money without the deduction) — the other spouse would only get $60,000.

I encourage my clients to try and figure things out.  Most of my clients would rather see more money go to the family members than the government.

This new tax issue won’t go away in 2019 when the new tax bill takes effect. New York uses a formula to calculate alimony payment amounts, and there is no guarantee it will change the laws any time soon.

The formula factors in tax deductibility for the payor. Judges and courts generally have broad leeway to deviate from the formula if they see fit and to establish payment amounts to account for increased take-home income for the receiver and increased costs for the payer. The legal standard in many states, like New York for example, is whether something is “unjust and inappropriate.”

There’s no guarantee that this gambit works, however. Judges, unlike written laws, are humans, and it’s very difficult to predict how all of them will deal with the changes.  Some judges will compensate for changes in the tax law and some will not. That is also going to create tension.