The New Tax Code’s Impact on Divorce

Divorces are difficult, but add to them the stress of trying to understand tax law, and the road ahead looks even darker. One bright spot in the pre-2018 tax laws was that a tax benefit existed in cases involving alimony. Under the IRS tax rules before 2018, alimony was tax deductible to the payor, while being taxable to the recipient. But this has changed under the most sweeping federal tax code overhaul in decades, the Tax Cuts and Jobs Act of 2017 (TCJA).

Alimony and Taxes

In instances where there is a sufficient difference in the income of divorcing spouses, alimony may be a part of a negotiated settlement or ordered by a court. Where a high-income earner is paying alimony, they are usually in a higher tax bracket, so the tax deductibility of the alimony can save the payor – and even the family unit as a whole – a significant amount of money. This savings is sometimes so important that parties with potential alimony payments will build all other financial aspects of the divorce around alimony and calculate which scenario will give the best tax break or keep the most money in the family.

For example, suppose William pays Mary $5,000 per month in alimony. Mary doesn’t get to keep $5,000 because it’s treated as taxable income to her.  Based on her 25% tax bracket, Mary’s actual monthly net is $3,750. Conversely, as William is in a higher, 40%, tax bracket, when he writes a check to Mary for $5,000, the deduction translates to an out-of-pocket cost to him of $3,000.

In practical terms, taxable alimony shifts income from a high tax bracket to a lower one.  Uncle Sam has been footing the bill on the $750 differential in tax revenue between the $3,750 that Mary nets and the $3,000 that it costs William. That is exactly what the new regulation in the TCJA is structured to eliminate.

The New Tax Law and Alimony

The TCJA does away with the tax deduction for alimony. Even though the recipient would take the alimony tax free, the total tax bill per family will go up. The payor would pay alimony with post-tax dollars and would no longer have the benefit of that alimony tax deduction. While the recipient’s net income would appear to increase, the higher tax payment overall for the family, in turn, will likely lead to lower alimony orders.

Of course, such concerns presume that parties won’t act collaboratively to obtain and share the best net tax outcome for their families.

Timing is Critical

The new law’s treatment of alimony applies only to spousal support paid under a divorce instrument executed after December 31, 2018 and doesn’t apply to alimony agreements entered before that. This means that people divorced prior to December 31, 2018 will continue to have their alimony payments deductible to the payor and taxable to the recipient. Meanwhile, those divorced after December 31, 2018 will not get that benefit.

Thus, it is critical that parties contemplating divorce, family law practitioners counseling them, and mediators assisting them understand the changing law and can intelligently weigh the risks and benefits of negotiating and filing for divorce in 2018, while the deductibility and taxability of alimony remains in effect.

Although couples may think they have until year-end before they need to worry about the changes, in Massachusetts, once a divorce is finalized by approval of a Joint Petition for Divorce by a Judge, there is still a 120-day waiting period before the divorce is final.  Therefore, the latest day you can have a hearing on a Joint Petition in Massachusetts to take advantage of tax deductible alimony is Friday, August 31, 2018.

Mediate Your Divorce

Finally, before you file for divorce, consider out-of-court dispute resolution before resorting to litigation. Mediation is a voluntary process that gives you and your spouse control over your divorce and its terms. Mediation allows you to privately discuss all aspects of your divorce, go over different options, and decide what is best for you and your family. Armed with the knowledge gained from discussion, you can easily write terms that work for you and give you flexibility when and where you want it.

If you or someone you know could benefit from assistance in decision making during a divorce, contact Falmouth Mediation at 508-566-4159 for a free, no-obligation, private, confidential consultation. We will be happy to discuss the key details of your situation, address any concerns, and help you decide if divorce mediation would be beneficial.

July 16, 2018 UPDATE

Recently, a client's attorney advised him that, contrary to my writing that the latest day you can have a hearing on a Joint Petition in Massachusetts to take advantage of tax deductible alimony is Friday, August 31, 2018, "only the judge's signature is required before the December 31, 2018  deadline, and the waiting period could roll into 2019 without affecting the tax deductible alimony payments."

I believe that the confusion, if you will, is because the IRS has not issued specific guidance on how they are going to interpret the language of the Tax Cuts and Jobs Act of 2017, specifically the language around alimony. 

The law says “ … divorce or separation instruments that are executed after December 31, 2018.”  Fellow mediators and financial planners that I know and trust have interpreted “executed” as meaning “come into legal existence due to a court order.”  Thus, because of the waiting period in Massachusetts (which, by the way, differs from state to state) they have counseled that the divorce must be final by December 31, which means signed by a judge by August 31.

In the absence of guidance from the IRA I am taking a conservative approach in that I would much prefer to be positive that decisions my clients make will hold up to an IRS decision than to hope that they will. 

Four Steps for Dividing Marital Property

One of the most important steps in creating a divorce agreement is deciding how you will divide marital (or joint) property. This is called division of assets.

In this excellent blog posting, Joy S. Rosenthal lays out the basic steps:

1. Identify all of the property either spouse owns. You must share detailed information with each other.

2. Value the assets. This is easy for bank and brokerage accounts, but you might have to hire a neutral appraiser to value a business or real estate.

3. Determine whether it is separate or marital property. This depends on a lot of different factors.

4. Distribute the Marital Property.

While dividing up the marital property often seems like an insurmountable task, a qualified attorney will have the resources and training to make sure every detail gets done.

Mediating Your Alimony Agreement - Part 4

This week I'm writing a series of blog postings on mediating your alimony agreement.   Yesterday I wrote about how alimony is supposed to work.
 
Alimony Solutions Through Divorce Mediation
 
Although alimony can be emotional, it is also an area that greatly rewards creativity when crafting settlement solutions. Below are just a few of the custom solutions a mediator can help divorcing spouses reach to resolve alimony:

1. Alimony buyouts – In many cases, parties can avoid alimony payments by adjusting the division of marital assets to provide the would-be alimony recipient with a larger share of assets in exchange for waiving the right to receive alimony in the future. Negotiating a fair buyout is an area where an experienced mediator can assist. Calculating buyouts often involves examining how much alimony a spouse could theoretically receive under the ARA, then generating a buyout based on the risk/reward between the certainty of a lump sump buyout and less certain alimony payments made over many years.
2. Child Support vs. Alimony – In cases with unemancipated children, child support and alimony are often competing issues. Depending on how much alimony a spouse could be theoretically entitled to under the ARA, versus how much a party may receive under the Massachusetts Child Support Guidelines, many mediated divorce agreements include custom solutions that balance alimony and child support in the most advantageous way possible.
3. Tax Deductibility – Starting in 2019, alimony will no longer be tax deductible for the paying party. The loss of the deduction will have a significant impact on alimony negotiations – and also creates a race to the finish for spouses seeking to take advantage of the deduction before 2018 ends.

Divorce mediation is uniquely suited to resolving alimony issue because mediation is designed to overcome strong negative emotions, while focusing on creating custom solutions that fit the real-world needs and interests of each spouse. Despite the emotional weight, alimony issues are often best resolved through creative settlements in which each party trades the uncertainty of litigation for a predictable compromise.

If you or someone you know could benefit from assistance in decision making during a divorce, contact Falmouth Mediation at 508-566-4159 for a free, no-obligation, private, confidential consultation. We will be happy to discuss the key details of your situation, address any concerns, and help you decide if divorce mediation would be beneficial.

Mediating Your Alimony Agreement - Part 3

This week I'm writing a series of blog postings on mediating your alimony agreement.   Yesterday I wrote about how alimony is supposed to work.

Discussing Alimony Can Be Emotionally Tense

Unfortunately, the issue of alimony payments can cause emotional tension between spouses because the amount paid – or whether alimony payments need to be paid at all – is determined by factors that may have led to the divorce in the first place. These factors under the ARA can include:

• The current or the potential income of each spouse,
• Contributions, both economic and non-economic, to the marriage,
• The marital lifestyle and the ability of each spouse to maintain it after the divorce, and
• Lost professional opportunities due to the marriage.

Each one of these is a potential landmine for disagreement and negative emotions, because they are often the very source of the disputes that led to the divorce, and now they have to be distilled into a dollar amount for the purposes of support payments. Alimony is also often complicated by the feelings each spouse has how the marriage ended. If one spouse feels he or she dutifully stuck through the marriage – through the good times and bad – only to be left by the other spouse, that is likely to affect both spouses’ perspectives on alimony.

In the end, alimony is highly symbolic. It represents the sacrifices made by both spouses during the marriage. What each spouse gave up, what each spouse put in. A lower-earning spouse may feel he or she sacrificed his or her career for the family, only to told they must fend for themselves financially, long after their professional opportunities dried up. A higher-earning spouse may feel he or she spent the entire marriage supporting the financial needs of the other spouse, only to find that he or she must keep paying – even if lower-earning spouse was the one who chose to end the marriage and file for divorce.

Divorce Mediation Keeps the Focus on the Future

It is very easy, and all too common, for alimony discussions to focus on the past. If one spouse sacrificed professional advancement to enable the other spouse to climb the corporate ladder, the alimony discussion may cause lingering resentment to resurface.

Divorce mediation minimizes these conflicts by keeping the focus on the future, not on what has already been said and done. The whole point of alimony and spousal support is to ensure that both spouses have some financial stability after the divorce.  Divorce mediation recognizes that alimony is not about retribution, but rather making sure that both spouses are able to live comfortably in their post-divorce life.

Tomorrow I'll write about alimony solutions through divorce mediation.

Mediating Your Alimony Agreement - Part 2

This week I'm writing a series of blog postings on mediating your alimony agreement.   Yesterday I wrote about why former spouses sometimes need alimony.

How is alimony supposed to work?

Gender is often a red herring in discussions about alimony. The alimony debate is often framed as husbands vs. wives, but the real issue is simply a matter of earnings. When one spouse earns significantly more than the other spouse, alimony is a potential issue in a divorce.

The purpose of alimony is to equalize – to a degree – the post-divorce income levels of spouses, thereby enabling the lower-earning spouse to approach (but perhaps not fully achieve) the lifestyle and station that the spouse enjoyed during the marriage.  By enabling the financially dependent spouse to receive support payments from the higher-earning spouse, both spouses can theoretically enter their post-divorce lives with economic stability.

In Massachusetts, alimony orders are constrained by the Alimony Reform Act (ARA), a 2011 statute that provided a comprehensive alimony framework. The ARA attempts to balance the post-divorce needs of spouses by capping the amount and duration of alimony. Under the ARA, alimony is generally limited to 35% of the difference between the parties’ gross incomes. The 35% “cap” is intended to provide the lower-earning spouse with an opportunity to maintain elements of the marital lifestyle enjoyed during the marriage – while acknowledging that the higher-earning spouse should nevertheless retain the majority of his or her earned income after the divorce.

In terms of duration, the ARA determines how long a spouse will receive alimony based on the length of the marriage. For a 5-year marriage, the ARA limits alimony to 2.5 years (i.e. half of the length of the marriage). For a ten-year marriage, the ARA limits alimony to 6.0 years (i.e. 60% of the length of the marriage). For a 19-year marriage, the ARA limits alimony to 15 years (i.e. 80% of the length of the marriage). For marriages over 20 years, ARA generally only limits the duration of alimony as follows: the paying party reaches federal retirement age, the receiving party remarries or cohabitates with a new partner, or either party dies.

It’s important to note that alimony orders are generally modifiable under Massachusetts law, and that judges are not required to follow the ARA if the facts of a particular case warrant a deviation. It can be difficult to predict the future at the time of a divorce, and the modifiability of future alimony can have a significant impact on negotiations.

Although the ARA provides Massachusetts judges with many guideposts for determining alimony, litigating alimony at trial is often highly unpredictable. Massachusetts appellate decisions are full of examples of Probate and Family Court judges deviating from the ARA in various ways. (Indeed, where the 35% cap is only that – a cap, not a rule – many alimony trials result in orders that are lower than the 35% difference. The point is: litigating alimony is unpredictable.)

Tomorrow I'll cover divorce mediation keeps the focus on the future.