Ending a marriage is rarely easy. The process has emotional and legal implications that take time to work through. For most couples, the financial aspects of divorce are the primary focus of settlement negotiations.
Additionally child support, asset division and other financial considerations, are also important concerns. The combination of these concerns are usually the most important factors in determining an equitable settlement to allow both spouses to begin the next phase of their lives.
Pending changes to the tax code, however, have caused lawyers to rethink alimony. These changes have significant financial implications for both spouses and may therefore affect how divorces are negotiated in the future.
What is Alimony?
Alimony is sometimes called spousal support or spousal maintenance. It is designed to prevent one spouse from having financial hardship after divorce. Alimony is not paid out in every divorce. It’s unlikely to a factor in settlement negotiations if both spouses make similar income or if the marriage was very brief.
However, if one spouse has significantly higher income than the other spouse and/or the marriage was a long-term marriage, the amount of alimony may be hotly contested issue. The actual amount of alimony depends on many factors. Alimony is not just an issue for wealthy couples. All spouses who choose to divorce, regardless of income level, may discuss alimony as part of a settlement.
How is Alimony Usually Determined?
Spouses are free to negotiate alimony in a divorce settlement, however the amount and length of alimony payments is very difficult for parties to agree upon. If you cannot agree, a judge may impose an amount to be paid. That amount is usually paid monthly, until a set date or triggering event.
That triggering event that would stop the payments might be if the receiving spouse remarries, or either party passes away or retires. Alimony can also end if a court decides the receiving spouse has had enough time to become financially self-sufficient.
What Are the Tax Implications?
For divorces commenced before December 31, 2018, both spouses report alimony on their respective tax returns. The paying spouse gets a deduction on the amount paid, while the receiving spouse is required to report it as income. For divorces that occur as of January 1, 2019, this will no longer be the case.
As of 2019 the alimony amount will no longer be deductible for payors. Receiving spouses will also no longer have to report it as income. On the face of it, this seems like a simple and sensible change. But it actually may have wide reaching implications for how divorce settlements are negotiated.
Real-Life Example: How the Tax Reform May Affect You
In its report on the tax changes, CNBC gave the following example of how the law currently works, and how it will change under the new legislation. Let’s say an individual in the highest tax bracket makes $500,000 per year. This person agrees to pay $100,000 in alimony but gets a $50,000 deduction under the current law. The receiving spouse gets $100,000, but because that spouse is in a lower tax bracket, the tax burden is only $25,000. In essence, the paying spouse is out of pocket $50,000 while the receiver gets $75,000.
How Does This Affect Future Divorces?
On the face of it, keeping the tax code away from alimony seems straightforward. However, some experts say paying spouses will be reluctant to negotiate higher settlements without the tax deduction. The person in the above scenario, for example, may claim $50,000 is the only affordable payment. The receiving spouse would receive that same $50,000 and not $75,000 under the former tax regime.
As it now stands, many divorce negotiators use a software program that calculates the net financial burden of alimony payments in order to get parties to come together. Now, advisors cannot use the tax break as a way to find a reasonable settlement that is fair to both parties. It can also make the overall calculation of property division more complicated.
Others who handle high net worth divorces, say it won’t be a big deal at all for wealthier clients. On the other end of the spectrum, still others say some couples simply won’t be able to afford a divorce and will therefore stay married.
Whom Do the Changes Most Affect?
The current law generally meant spouses paid less overall in taxes. In some ways, this seems fair because the former couple now has the added expense of maintaining two homes instead of one, as two separate individuals.
With the changes in place, it means it may be more difficult for lower income people to afford alimony payments. After all, if the tax break amounted to a few hundred dollars per month, that is the same as a car payment or utility bill. For these former couples, it may be more difficult to come to a fair arrangement that everyone can afford.
Get More Information
The takeaway from this discussion is that no one knows yet how the tax changes will affect divorcing couples. To learn more about how tax changes may affect you, contact a lawyer at Kaspar & Lugay LLP.