The new GOP tax bill – the "Tax Cuts and Jobs Act" – was signed into law by President Trump on December 22, 2017. While everyone is focused on the various tax brackets, the reduction in the corporate tax rate, and caps on state and local tax deductions, a portion of the new law that will impact people in every state and almost every tax bracket is being overlooked. What most news networks are not addressing is that the Republican Party's new tax law eliminates the alimony payment deduction for divorces finalized after December 31, 2018.
The breakup of the family unit is, unfortunately, a real possibility for everyone in both political parties and across socioeconomic classes. In the U.S, a divorce is filed every 13 seconds. Millions of couples have to deal with the issue of alimony. As such, consideration of the impact of the tax plan on divorced couples should not be a partisan issue. The harsh truth is that the new tax law will have a negative financial impact on divorcing parties.
Here’s what you need to know.
Under the new GOP tax law, alimony will no longer be deductible for the paying spouse starting December 31, 2018. Until now, the paying spouse would deduct the amount of spousal support (alimony) paid from his/her income, and the receiving spouse would have to claim the spousal support received as income and pay taxes on it. With this change, the paying spouse will not be able to deduct it from his/her income, which means the paying spouse will pay taxes on the amount of alimony at a higher tax rate.
Why is this bad news for divorcing parties? Because the paying spouse is typically in a higher tax bracket than the receiving spouse. As such, if he/she cannot deduct the alimony from his/her income, the amount gets taxed at a higher rate and less is left for each party.
Here is an example. Let’s say that Greg pays $5,000 per month in spousal support to Sandy. Let’s say Greg was in the 32% tax bracket and Sandy was in the 22% tax bracket. Prior to the change in the law, he would not pay taxes on the $5,000 per month paid in alimony because he would be able to deduct it from his income. Sandy would pay taxes on the $5,000 at her tax rate.
Under the new GOP tax law, however, the $5,000 is now taxable for Greg because of the elimination of the deduction. Now he will have to pay $1,600 in taxes on the $5,000 he pays to Sandy every month ($5,000 at 32% tax rate). Assuming that Sandy is in a lower tax bracket such as the 22% tax bracket (because the receiving spouse is typically a lower earner), then under the old law, Sandy would be paying the taxes on the $5,000 per month she would receive. At her lower tax bracket, she would have paid $1,100 in taxes from each month’s alimony payment.
The result of the new GOP tax law is that Greg and Sandy together will be paying $500 more in taxes on the same funds, under the new law. That means there will be less money to go around for both of them. When considering the fact that after a divorce the couple has to support two households instead of one, paying even a few hundred dollars more in taxes has real implications on people’s monthly cash flow.
You may be wondering why the change is bad if the receiving spouse does not have to pay taxes on alimony anymore. It is bad because the receiving spouse would receive less in alimony. The fact that the paying spouse has to pay taxes on the alimony at the higher tax rate has to be taken into consideration when calculating his/her net disposable income for the purpose of payment of alimony.
While some argue that the change eliminates a tax subsidy for divorced couples (“Why should they be able to deduct anything related to support?”), the reality is that it creates a tax penalty for them. When we consider deductions for married couples compared to that of single individuals and we eliminate the deduction for alimony, divorced couples will end up paying higher combined taxes compared to what they would have paid as a married couple. The impact may be devastating for many people.
Furthermore, when calculating guideline child support and temporary spousal support, most family law attorneys in California, where I practice, use a program called "Dissomaster". Dissomaster takes the formula set by the California legislature and calculates guideline child support as well as temporary spousal support. This calculation creates the parties’ net disposable income, taking into consideration the parties’ tax burden. When inputting information into Dissomaster, the amount of monthly interest paid toward home mortgages and property taxes are taken into consideration because these can be deductions on tax returns. The program also considers whether the paying spouse can deduct the payment of spousal support (alimony). When including these items, the paying spouse’s net disposable income goes up, because the more deductions the paying spouse has, the less in taxes he/she will owe. The higher the net disposable income, the more support would have to be paid.
Under the new GOP tax law, however, the deductions are less. For example, there is a cap of $10,000 total for state and local taxes, including property taxes and a cap of mortgage interest deductions for interest paid up to $750,000 in mortgages. Accordingly, the natural consequence in limiting the deductions will be that the net disposable income may go down. Accordingly, there will be changes to the availability of income for the purpose of fixing child and spousal support that may be bad for people in high-tax states such as California. This is something the California legislature should be tackling now.
There is some good news in the new tax law. The tax rates for some brackets have gone down, and the child tax credit has gone up. How that will impact the bottom line, we still need to see. For now, it seems that no matter how you look at it, parties going through divorce where alimony is an issue will be negatively impacted by the new tax law. There will be less money left after taxes, and there will be less support available to the receiving spouse.
What can be done about this? If you are seriously considering going through divorce, then start the process now! This portion of the new tax law is set to take effect on December 31, 2018. That means that if your divorce is final prior to December 31, 2018, then the alimony tax deduction is available under the old law. In order to get your final divorce decree by that date, however, you have to start the process now. In California, you cannot get a divorce judgment earlier than six months from the time you file and serve the petition for dissolution of marriage.
In some counties in California, including Los Angeles County, the processing time even for divorces that have settlement agreements or stipulated judgments can be two months or longer. Assuming that the news of the new tax law gets out, divorce lawyers will be scrambling to file their divorce judgment packages in the last quarter of 2018, which will result in a further drain on the court system and a slowdown in the processing time. Accordingly, if you want to finalize your divorce before the end of the year to get the tax deductions under the old law, then you’d better get going now.
Marina Manoukian is the Head of Family Law at ADLI Law Group, PC In Los Angeles, California. Her practice focuses on assisting individuals who are seeking a divorce to reach agreement on their dissolution issues, including property, custody, and support. ADLI Law Group, PCBack To Top
Certified Divorce Financial Analyst
Business Valuators / CPAs