Alimony Under The Amendments To The U.S. Tax Code: The Clock is Ticking
With the recent passage of the Tax Cuts and Jobs Act (the “Act”), the longstanding federal income tax treatment of alimony will change. The act signed into law by President Trump, amends Sections 215(a), 61(a)(8) and 71(a) of the Internal revenue Code of 1986 (the “Code”) to eliminate the tax deduction for alimony to the payor spouse and similarly eliminate the requirement to include alimony as income of the receiving spouse. The act strikes Sections 215 and 71 from the Code and amends that portion of Section 61 eliminating alimony and separate maintenance payments from the definition of gross income. The provisions of the Act that deal with alimony are delayed one year and will apply to “divorce or separation instruments” executed after December 31, 2018. The Act will also apply to modifications done after December 31, 2018 if the terms of the modification dictate that the amendments apply to the modification of the prior agreement.
Since the adoption of the Revenue Act of 1942, the definition of gross income has included “amounts received as alimony or separate maintenance payments” while current Section 251reads “there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year.” Offered as a rationale for the changes to the Code sections dealing with tax treatment of alimony, the House of Representatives Conference Report on the Act cited the new alimony provisions as bringing the law in line with the 1917 U.S. Supreme Court Case, Gould v. Gould, 245 U.S. 151 (1917). This seems to be a dubious citation since, at the time, Gould was interpreting the inclusion of alimony as income under the recently enacted Income Tax Act of October 3, 1913. It is doubtful that 76 years later, the need to bring the tax code in line with the holding of a generations old case is the real reason for these changes. It’s safer to assume that this shift in tax policy is for a very practical reason that is readily apparent – a method to bring more revenue into the Federal Treasury without raising taxes.
Currently, the general orthodoxy is that the payee spouse who claims alimony as income on their return is normally in a lower tax bracket than the payor spouse who claims the deduction. As such, the dollars paid now in alimony are likely subject to less tax liability by being assessed to the receiving spouse in the lower tax bracket. That aside, the real policing done by the new Act will be to combat a reported compliance issue. For example, government statistics show that while 361,000 individuals claimed that they paid alimony in 2015, only 178,000 taxpayers reported receiving the income as support. In attempting to remedy the compliance issue of voluntarily reporting your alimony received, the Act will now yield increased tax revenue on all of the not normally reported income as well as to tax those same dollars at the higher rate generally paid by higher income payor spouses. This will result in windfall for the government not by raising taxes, but by simply taxing more of the same dollars differently.
The individual loss of the alimony deduction is best demonstrated by looking at how it gets applied on the tax return. Currently, alimony is deductible whether or not you itemize deductions at all. The alimony deduction is an “above the line” deduction that subtracts, dollar for dollar, from your gross income before calculating the Adjusted Gross Income (AGI), the amount closer to the amount from which your taxes are calculated. The alimony deduction has the same effect on your taxes like other planned discretionary and necessary deductions have like saving for retirement or saving for a child’s college education. It is an invaluable tax planning tool. As such, the loss of the alimony deduction could in many cases be even more devastating to those that might count on it especially with the now effective limiting or elimination of certain itemized deductions.
What is lost in the analysis and in the gamesmanship that filing strategies and tax planning often becomes is the true effect that this change could have on families, especially with all other current provisions of state law and procedure remaining as is. It is not an exaggeration to say that the state laws dealing with the child support guidelines and other rules dealing with support now may need to react quickly to this change suddenly foisted upon them instead of controlling any possible negative effects prior to its application. Will one year be enough to enact any needed ameliorative legislation and/or rules?
These changes will necessarily force us as attorneys with active cases to ask, what if anything will the new deductibility rules do to the calculation of child support after application of the Act and should the timing of our cases (if it can be managed) need to be examined for any benefits or negative impacts associated with the changes to alimony and consequent effect on child support. Since child support is calculated in different ways in cases dealing with spousal support or alimony, an analysis of each scenario is warranted when attempting to advise clients.
When calculating child support in cases where spousal support is warranted by the formula set forth in Pa.R.Civ.P 1910.16-4, the guideline child support amount is awarded first by only using the gross incomes and net incomes of the parties. Only then an amount for spousal support is calculated if warranted by the formula. The effect of deductibility or not and overall tax obligation(s) do not come into play until after the spousal support amount is calculated, and, as such, the guideline child support calculation made pursuant to Pa.Civ.P 1910.16-3 is unaffected by the new tax policy.
This situation is substantially different when post divorce alimony is being calculated. Alimony, which is awarded by employing a needs based analysis will be calculated before a new post divorce child support obligation. Indeed, knowing the alimony amount is necessary to reaching the correct child support guideline calculation. In order to calculate child support for someone paying alimony, an obligor’s net income will take into account the reduction for any alimony paid as well as the tax consequences associated with deductibility or non-deductibility of the alimony payment now and after end of 2018. Non-deductible alimony will cause the net income amount from which a guideline child support obligation is based to be lower, and consequently, a lower child support obligation will be calculated. Combine that lower child support award with the increased tax burden of the alimony and the result is less income overall being available to both parents to support their children in a non-intact family. It is not an exaggeration in this context to argue that the government is the beneficiary of the new policy change at the expense of families and children.
In terms of awarding alimony in general, one wonders whether the loss of the deduction will influence courts to award less alimony. While no statutory or formulaic reason can specifically be cited for doing so, the entirety of the family law bar, as well as judges and masters have all “grown up” taking into account the tax consequences, both pro and con, into settlement and negotiation of divorce cases (and orders). Indeed, this circumstance in an individual case can actually be used to aid settlements when the calculable reduction in net dollars paid in taxes on the same money if paid as alimony to a spouse in a lower tax bracket will result in more disposable income overall to the parties. Many attorneys have seen or fashioned settlement agreements with the alimony paying spouse being responsible for the lower tax liability of the spouse receiving alimony. Such arrangements will no longer be an option.
The Act may also provide an incentive for practitioners in certain cases to either hurry to settle or try their matters before the end of this year, or delay if the financial incentives to their clients warrant that. The ability to also dictate the application of the Act to modifications after 2018 of prior agreements adds another level of complexity. It will also be interesting to see if courts, for equitable reasons, are permitted or willing to apply the provisions of the new Act to post 2018 modifications of prior agreements or alimony orders. It should be an interesting year (and after) for family and matrimonial lawyers who now must navigate the “what if’s” present in their cases now accompanied by a deadline that could either enhance or hurt their clients’ positions. The clock is ticking.
Disclaimer: The contents of this post are for informational purposes only, are not legal advice and do not create an attorney-client relationship.
For more information please contact John Zurzola at firstname.lastname@example.org or at 610-272-5555