The US House of Representatives Committee on Ways and Means has published a draft of the “Tax Cuts and Jobs Act” and it includes a very interesting provision that is highly relevant to divorce matters. Section 1309 is entitled “Repeal of deduction for alimony payments” and states:
Under the provision, alimony payments would not be deductible by the payor or includible in the income of the payee. The provision would be effective for any divorce decree or separation agreement executed after 2017 and to any modification after 2017 of any such instrument executed before such date if expressly provided for by such modification.
Under the current law, alimony is includible in the income of the payee and deductible by the payor and most support payments are determined considering the impact of this current tax law. If this part of the Tax Cuts and Jobs Act stays in place, it could result in a windfall to any payee if the support calculation is not modified to reflect the new after-tax result of this change.
In other words, assume that support is set with the assumption that the receiving spouse will be paying taxes on it and thus netting less than the gross amount. So under this hypothetical, the payee receives $1,000 a month, from which he or she pays 25% in tax, thus netting $750. Similarly, the cost to the payor is $750 (assuming that the payor is also in the 25% tax bracket). If the law is enacted, all else being equal, the payee would now net $1,000 (since no tax would be paid) and it would cost the payor $1,000 (since the previous tax benefit would be eliminated); as a result, the payee receives an increase in support relative to the treatment under the previous law and despite no change in the relative incomes of the former spouses. In theory, reducing the support payment to $750 returns each party to their previous position.
The good news is that this is a problem that can be solved with math! But it won’t always be easy math. There are two apparent problems:
- What happens if the payor is in a higher tax bracket than the payee. Assume that the payor is in a 40% tax bracket and the payee is in a 25% bracket. In our above example, the cost to the payor was $600 ($1,000 * 1-40%) and the benefit to the payee was $750 ($1,000 – 1-25%). Under the new law, the payor would pay $1,000 ($400 more than before) and the recipient would receive $1,000 ($250 more than before). In this case, who bears the $150 difference?
- Further, the provision applies to “any divorce decree or separation agreement executed after 2017 and to any modification after 2017 of any such instrument expressly provided for by such modification.” As written, this language is not clear as to whether a decree signed prior to 2017 but modified post-2017 would be subject to the new tax rules or the old.
Because it will take some time for all of the versions of this bill to work its way through our legislative process, there will likely be divorce cases settled during a time period of uncertainty as to how alimony will be taxed and whether if passed, the new law would be retroactively implemented or start at some future date.
Keep in mind this is a bill in its infancy and will likely undergo many iterations before anything is finalized; however, we will be keeping an eye on the situation for you. It is interesting that early estimates indicate that this provision would provide $8.3 billion in revenues from 2018 to 2027.
Stay tuned for updates as they develop!