IRS overhaul throws divorce calculations into turmoil
In the often messy financial negotiations that are part of divorce, one rule has always been clear across state lines for 75 years: Alimony was deductible for the payer, and the recipient paid income tax on it. Now, President Donald Trump’s tax code overhaul has thrown that relied-upon calculation into turmoil, causing confusion for matrimonial lawyers, mediators and, most important, divorcing couples trying to reach financial settlements.
Divorce lawyers say uncertainty about the new law, which takes effect Dec. 31, 2018, as part of the Tax Cuts and Jobs Act, is causing an uptick in some unhappy couples scrambling to split before the year-end deadline, while others may decide it’s better to drag their feet.
“Both lawyers and litigants are aware of the deadline and are gearing up,” says Lester Barclay, principal of the Barclay Law Group in Chicago. “There’s going to be a lot more litigation and a lot more fighting.”
The inability to deduct alimony payments will make negotiations more contentious, he says, because the higher-earning spouse will be less willing to agree to bigger payments. Previously, both sides benefited: The provider was able to reduce his or her taxable income, while the recipient, of course, gained more support.
“I’ve never seen anyone walk out of court thrilled to pay, but the deduction was a spoonful of sugar,” says Rhonda de Freitas, a clinical associate professor at Chicago-Kent College of Law.
But while high-earning spouses have reason to hustle through divorce proceedings this year, dependent spouses may have reason to drag out the process. That’s because the tax overhaul also ends the requirement that recipients pay taxes on the alimony as though it were regular income.
Proponents say the changes will be easier for the IRS to monitor. Current tax data shows that one spouse will sometimes deduct alimony, but the money doesn’t get reported as income by the recipient.
The new law essentially “moves the tax burden from the payee to the payer,” Barclay says. And though this may seem to benefit the dependent spouse, the only real winner is the federal government.
Consider this: In higher-earning families, the breadwinner’s income is often taxed at 35 percent, while the dependent spouse may be in the 15 percent bracket. Under the current tax rules, the payer was incentivized to pay more alimony not just because of the deduction but because the money would be taxed at a significantly lower rate in the recipient’s possession.
“The beauty of the deduction was the ability to float some income from one side of the family balance sheet to the other without Uncle Sam getting his hands on it,” de Freitas says. When the breadwinner loses the alimony deduction, he or she may claim to be able to afford 35 percent less support.
The dependent spouse, meanwhile, won’t have to pay taxes on that money—but because he or she is in, say, the 15 percent bracket, that savings doesn’t counteract the 35 percent hit. In the end, this scenario nets out to 20 percent more alimony money going to taxes—and 20 percent less staying in the family.
According to Congress’ nonpartisan Joint Committee on Taxation, eliminating the alimony deduction will add $6.9 billion in new tax revenue over 10 years. That loss is far more perilous to poorer divorcing couples, de Freitas says. As these couples cope with the extra expenses associated with establishing two separate households, every dollar counts. The current tax structure helps ease that burden.
“My fear is the people who will be the most harmed are the spouses on the edge,” she says. “The people on the higher end of the wealth spectrum won’t really feel it, as opposed to a firefighter earning $75,000 a year, supporting an ex-wife and two kids.”
Ultimately, de Freitas adds, this squeeze will be bad for women and children. According to the U.S. Census Bureau, 98 percent of the 243,000 people who received alimony last year were female. “Though I’m a fan of flattening the tax code, I’m not sure this is how I would have chosen to do it,” she says. “The result is that there’s going to be children who have a lower standard of living.”
This article was published in the June 2018 issue of the ABA Journal with the title "Until Tax Deduction Do Us Part: IRS overhaul throws divorce calculations into turmoil."