There’s nothing fun about a divorce. Ever.
There’s nothing fun about a divorce. Ever.
The arguing, tears, moving out, fighting over kids, splitting up property, hiring lawyers, talking to lawyers, paying lawyers. No matter how friendly or cordial you and your spouse are it all adds up to be a generally unpleasant, difficult experience. It just does.
And if you have been married for a long time, and if one spouse has been the primary breadwinner, the issue of spousal support (“alimony”) is going to be a major sticking point in any negotiation towards settlement.
But until now, from a tax perspective, the issue of alimony in California divorces has been relatively straightforward: the paying spouse (the “payor”) could deduct the alimony payments from his or her taxes; and the receiving spouse (the “payee”) had to claim the alimony payments as income on his or her tax return.
This deductibility of alimony was governed by Internal Revenue Code (“IRC”) Section 215, which, until December 2017, previously read as follows:
(a) General rule
In the case of an individual, there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year.
(b) Alimony or separate maintenance payments defined
For purposes of this section, the term “alimony or separate maintenance payment” means any alimony or separate maintenance payment (as defined in section 71(b)) which is includible in the gross income of the recipient under section 71.
For example, let’s say a husband and wife were married for 15 years. The husband was the primary earner making $200,000 per year in taxable income as a partner in a law firm. The wife was a stay-at-home mom who handled domestic duties and raised the kids, and earned no income. When they divorced, the husband agreed to pay the wife $3,000 per month in spousal support until husband died, wife remarried, or wife died.
When tax season came around, husband used to be able to write off $36,000 from his taxes, whereas the wife was required to claim as income (and pay taxes on) that $36,000. This left the husband with $164,000 in taxable income, and the wife with $36,000 in taxable income. The tax deduction helped offset the cost of the husband’s monthly spousal support obligation, and Uncle Sam collected a percentage of wife’s $36,000 income. Simple, right?
Well, with the passage of the new tax law in December 2017, things have changed.
The “Tax Cuts and Jobs Act” (Bill H.R.1 in the 115th Congress) repeals the deduction for alimony payments for the paying spouse, and eliminates the requirement that the receiving spouse claim as income and pay tax on the alimony payments he or she receives. You can read the entire bill here.
This new law has some interesting and important implications for you and your spouse as you work through your pending California divorce.
In a nutshell, IRC Section 215 is repealed, and the alimony paid by the payor spouse can no longer be deducted from his or her taxes. Instead, this alimony (e.g. $36,000) must be included in the payor spouse’s income.
This reduces the amount of income available to the payor spouse; and, as a result, the amount of money available to pay the payee spouse.
For instance, under the old law (using our example above), if the paying spouse was paying $3,000 per month at a 33% tax rate, the deduction of the $36,000 per year made that effective payment only $2,000 per month. The $36,000 tax deduction made the $3,000 per month an easier pill to swallow for the payor spouse.
On the other, under the old law, the payee spouse (the wife) would have to claim that $36,000 per year as income. If she was paying an effective tax rate of 15%, then $450 per month was going towards taxes, and her net benefit was equal to $2,550 per month.
Under the new law, the husband is unable to reduce the $36,000 from his taxable income. And the wife does not have to claim the $36,000 as income, at all. Effectively, the law shifts the tax burden from the payee spouse (where the tax bracket is usually lower) back to the payor spouse (where the tax bracket is usually higher).
Ultimately, this leaves less money in the pot for both the paying and receiving spouse. But it puts more money into Uncle Sam’s pocket. As you can imagine, this is likely to be a huge point of contention for parties trying to work out an agreement on this issue. And it will make an already delicate issue more complicated to resolve without a Court order
This law goes into effect for any California divorces finalized after December 31, 2018 (or for any divorces finalized before such date that specifically references these provisions). So, if you are looking at an alimony obligation, and are in the process of negotiating a divorce settlement, you should start thinking about how to finalize the agreement before the end of the 2018 calendar year. You should also discuss the effects of the new law with your legal and tax advisor as soon as possible.
A divorce is stressful enough with worrying about the impact of new, uncharted laws and tax obligations. The goal should be to finalize your divorce efficiently, amicably and to move forward with your life – not to get bogged down in years of expensive, stressful litigation and court dates.
If you have questions, please don’t hesitate to reach out to us at The Broadway Law Firm at (213) 344-0545 to set up a low-cost consultation to discuss your case. We are here to help.