Alimony & Acrimony

When the Tax Cuts and Jobs Act of 2017 was signed into law by President Trump on December 22, 2017, and rolled out to the American public, many of the provisions were widely known ahead of time, since they had been debated and argued over quite publicly in the preceding months. Much hand-wringing and scrutiny had occurred over many of the proposals, some of which made the cut, while others did not. By the time the bill was signed, we were all quite familiar with potential changes like the reduction of SALT (state and local taxes) deductions, increasing estate tax exemptions and tax bracket modifications.

But one change that was included in the final bill seemed almost to fly under the radar at first, at least for all but a few professionals who deal directly in the areas of taxation and divorce, and only in recent months does it seem to have garnered the attention of the rest of the financial world.

For the previous 75 years, as enacted by the Revenue Act of 1942, alimony paid from one spouse to another as a result of divorce proceedings, was considered taxable for the spouse who received it, and tax-deductible for the spouse who paid it. Once the new bill was signed into law, however, that provision had been flipped on its head, and the opposite was now true – alimony was no longer deductible for the paying spouse nor taxable for the payee.

The motivation for this change in the new law is not entirely clear. The talking points suggest that it’s about collecting all of the revenue due to the government, which, it is argued, currently it is not. The statistics rolled out indicate that the payers have potentially been over-reporting the amount they pay, and the payees have been under-reporting the amount they receive, or some combination thereof. By making this change, we’re to assume, the government can close the gap, and collect all of the tax revenue that is owed, which is needed to help offset the loss of revenue from the cuts throughout the rest of the bill.

That would seem to make sense, and at first glance, the change looks to favor the lower-earning spouse, since he or she is no longer claiming the alimony as income, and thus, saving on taxes. More generally, it could be said that this reversal looks to be a win for women, since traditionally (though the trend has been changing), it is wives, by a wide margin, who have been more likely to receive alimony post-divorce.

However, the more cynical among us, have wondered about this, since it would seem so uncharacteristic for this administration, which ultimately crafted the new tax law, to provide relief to this segment of the population. Since it has been widely accepted that the vast majority of benefits from the changes made by the Tax Cuts and Jobs Act favor the wealthiest Americans, why did the administration choose to include this shift, which on the face of it seems to greatly favor the lower-earning (and most often, female) spouse? Perhaps we will never know, but what appears to be happening in divorce proceedings throughout the country, is not what we necessarily expected at first.

What we now know, is that divorces are becoming more contentious due to the modification of the taxation of alimony.

For this year, you have some spouses who are pushing hard to complete their divorce proceedings by the end of the year, since any settlement reached before December 31, 2018, will still be governed by the old rules, and thus, the higher-earning spouses will still be able to deduct their alimony payments from their taxable income going forward. In some cases, higher-earning spouses who understand the new law, are pushing this in the hopes that the other, less financially savvy spouse, and/or their lawyer, do not. And in cases where it is discovered by the other spouse that this may be the motivation for the rush, the response is generally not positive.

Additionally, many experts are predicting that the end result will be less support actually being paid out to the lower-earning spouse. Here’s an example to illustrate this line of thinking: a husband who earns $400,000 per year and is in the top tax bracket is paying $100,000 per year to his wife in alimony. Under the current law, after taking the allowed tax deduction, that only costs him $50,000. The ex-wife nets $75,000 per year after taxes since she is in a lower tax bracket. What some expect will likely happen after the new law, is that the husband will argue he can still only afford to pay $50,000, which would result in a net loss to the ex-wife of $25,000 per year.

Clearly this could cause more contentious divorce proceedings, and many in the industry foresee more cases ending up in litigation, rather than being settled out of court, which benefits no one, save the litigating attorneys.

Going through a divorce is such a trying procedure to begin with, that any mechanism which makes it easier to come to an acceptable agreement is invaluable. The deductibility of alimony was widely seen among divorce professionals as a key tool in helping couples find a palatable solution, and get settlement agreements completed.

Now that tool is gone.

What, at first, may have looked like a common sense provision to collect tax revenues that were due, and perhaps give some tax relief to lower-earning spouses after a divorce, appears now to be a marginal increase in revenue, that almost surely will increase acrimony among divorcing couples, and result in lower alimony payments to those lower-earning spouses. For this administration, and in this current environment, that sounds more like what was intended.