Bye-bye love, hello taxes: alimony tax deduction ends
Appeared as part of the sponsored section, 2018 Law Journal, in the September issue.
J. Gregory Hatcher
Hatcher Law Group
The terms alimony, spousal support and maintenance typically refer to money paid by one separated spouse to another in a set amount over a set period of time. It is not child support but instead, support which enables the receiving spouse to maintain the standard of living that was achieved during the marriage, in addition to paying for certain expenses he or she could not otherwise afford without the other spouse’s assistance. Hundreds of thousands of Americans pay alimony each year. Under the 75-year-old federal law, alimony payments are deductible from the paying spouse’s gross income while the receiving spouse must report the payments as taxable income. The purpose of the tax benefit is to help bridge the financial gap created when spouses separate and two households are created. Recent tax changes will determine if, and how, many spouses receive alimony in the future. Now, to receive a tax deduction for alimony payments made, spouses must either reach a signed agreement as to alimony or have an order resolving alimony entered before January 1st, 2019. As a result, family law attorneys are scrambling to help their clients resolve alimony claims before the end of the year, at which point they lose a valuable tool they have depended on to reach settlements and assist clients reach their financial objectives.
How things work under our current tax law.
In North Carolina, only a spouse who earns more money than the other spouse can be required to pay alimony. As a result, the spouse receiving the alimony is typically in a much lower tax bracket such that the alimony received is taxed at a much lower level than if it had simply remained as income of the paying spouse. Under our current tax code, alimony dollars can be stretched further with the tax deduction available to the supporting spouse. For instance, if the supporting spouse has $6,000 a month available to pay as alimony to the dependent spouse ($72,000 per year), but the dependent spouse needs $8,333 of alimony per month ($100,000 per year), the current tax code allows the supporting spouse to adjust his withholdings and typically reach the $8,333 per month alimony goal. The supporting spouse would be able to rely upon the tax deduction to “find” more after tax dollars to pay the dependent spouse.
Rationale for the changes to the tax code.
In 2017, the government put in place a sweeping tax reform that included the abolishment of the alimony deduction. The Joint Committee on Taxation was of the opinion that divorcing Americans had an advantage over married Americans through what they describe as a “divorce subsidy.” The divorce subsidy is created as follows: husband pays wife $100,000 per year in alimony. Husband is entitled to adjust his gross income through a $100,000 deduction for the alimony he paid in that year. Given his presumed high tax bracket, husband is assumed to save $50,000 in taxes. Wife, on the other hand, reports as income the $100,000 of alimony she received, but only pays $20,000 in taxes because of her low tax bracket. The net difference is the $30,000 between what husband saved and what wife paid. The government lost out on $30,000 of tax money. As such, the federal government considered this tax break ripe for abolishment in its efforts to reduce the federal deficit. It has been argued that elimination of the alimony tax deduction will increase federal revenues by $7 billion over a 10-year period. However, it is important to realize that the $7 billion in presumed savings accounts for less than half-a-percent of the current federal deficit. It is also important to consider the ramifications on parties as divorcing couples attempt to negotiate a settlement without this tax deduction.
The reality of the tax changes. As between the spouses.
Some may initially believe that the new tax law will benefit the spouse receiving the alimony. After all, the receiving spouse will no longer have to claim the alimony payments as taxable income, which should result in more support for the dependent spouse. However, the opposite is likely true. Supporting spouses will negotiate harder for a reduced amount of support. Lawyers will no longer have the ability to “find” money to pay the additional support needed. Litigation will likely escalate and more fees will be incurred by both parties. Even after an amount is settled upon by the parties or ordered by a judge, the impact on the receiving spouse continues. Using the example above of a dependent spouse needing $8,333 of alimony per month, the supporting spouse will now only have $6,000 to pay the dependent spouse. The dependent spouse will receive $27,996 less in alimony. The dependent spouse is already in a lower tax bracket than the supporting spouse, so the loss of overall support is probably more significant than the benefit of the non-taxable nature of the alimony. The decrease in the overall amount of alimony is further compounded by future reductions in child support. Frequently, it is the case that spouses who receive alimony served as a stay-at-home parent during the marriage and receive child support after the parties separate. Although child support is non-taxable, in North Carolina, the obligation to pay it typically ends when the child graduates from high school or turns 18—whichever comes later. Child support can help a spouse pay the bills if there is a shortfall in alimony. But if that same spouse is receiving less alimony from the beginning, he or she is doubly harmed when the child support ends.
Pre- and postnuptial agreements.
A prenuptial agreement is one created by parties who intend to marry. A postnuptial agreement is one created by parties who are already married but not yet separated. Both types of agreements attempt to resolve future issues between the parties such as property distribution and alimony obligations. Since the current tax law has been in effect for 75 years, it is likely that most pre and postnuptial agreements were based upon the assumption that alimony would be taxable to the receiving spouse and deductible by the paying spouse. No IRS opinions have addressed the impact of the new tax law on these agreements or future modifications under the new tax law. There are significant questions as to whether these agreements would meet the IRS code’s requirements to allow for the alimony payments to be tax effected as under our current law. No party to such an agreement should want to be the test case on these issues with the IRS or any other government agency.
What to do? Be proactive.
• Spouses who anticipate a separation in the foreseeable future should consult with a family law attorney immediately to determine how the new tax law will impact their case. Communicate with your tax expert or financial divorce planner and your family law attorney to calculate the actual tax effect on the paying and receiving spouses. Also, confirm that your settlement agreement or order meets the requirements of the new tax code.
• Spouses who are already separated would be wise to aggressively attempt to resolve alimony claims on a permanent basis before the end of 2018 and before the court docket is full.
• Do not make any assumptions. There is no indication that parties who have temporary alimony orders entered in 2018 will be allowed current tax benefits for permanent alimony orders entered after 2018.
• If you have a prenuptial or post-nuptial agreement that was created without reference to the new tax laws, see a family law attorney to discuss revisions and possible re-negotiation. Remember that the payor and the payee both have incentives to avoid the impact of the new tax law. If you are happily married, re-negotiation may go smoothly.
J. Gregory Hatcher is managing partner at Hatcher Law Group, P.C. who has dedicated nearly 25 years to representing clients in complex family law matters. He is a Fellow of the American Academy of MatrimonialLawyers, and a recognized Board Certified Specialist in Family Law by the North Carolina State Bar. Greg has achieved peer and industry recognition with honors that include North Carolina Super Lawyers, Business North Carolina magazine’s Legal Elite in Family Law, and Martindale-Hubbell’s AV Preeminent Peer Review Rating.