Divorce and Tax Reform

It’s not a fun topic, but it’s reality, and we should talk about it: divorce. And, in the era of tax reform, divorce requires a new level of planning.

The Tax Cuts and Jobs Act, which we’ve covered extensively, changes significantly the tax implications surrounding divorce. For some 76 years, in accordance with The Revenue Act of 1942, alimony payments have been deductible to the paying spouse and taxable to the recipient. That’s changing. Beginning in 2019, alimony will no longer be deductible by the payor and the income will not be taxed to the recipient. This has the potential to significantly impact divorcing couples, particularly those couples where one partner earns substantially more per year than the other.

Divorce agreements signed before the end of 2018 will still qualify for the annual deduction.

Under current IRS guidelines, individuals paying alimony can deduct those payments — no matter how big the amount — from their income before calculating what they owe in taxes.  This deduction has provided the most significant benefit to the wealthiest Americans, whose top tax rate is 37%, and who would otherwise owe taxes on all of their income, including what they paid out in alimony.  Historically, if the person paying alimony earned substantially more than their soon-to-be ex-spouse, he or she would generally negotiate a higher alimony payment because he or she could then deduct the full amount from his or her income. The former spouse, who earned less, paid a lower tax rate on alimony payment. It’s conceivable, in light of new tax law, that the paying spouse will now argue for lower payments to make up for the lost tax break. Regardless of what side you’re on, payer or payee, you need to get with your divorce attorney and CPA immediately to set your course of action.

As for child support payments, those are not deductible, but so-called unallocated support — payments that are meant to help a divorcing spouse and children at the same time — is deductible. That deductibility will also end for any new or modified divorce agreements, starting in 2019.

If you’re a business owner headed for divorce, you need to be especially aware, as tax reform has changed the valuation of businesses, which could impact your financial outcome in the divorce. The cash flow will increase for flow-through entities, and the consequence of that will be that the business can be valued at a higher amount. This will significantly impact business owners’ overall net worth and overall division of assets, as well as any alimony payments. The non-moneyed spouse will also need to make sure that the assets they receive are unencumbered — meaning no liens or hidden capital gains taxes to be paid. Again, check with your attorney and CPA.

Pension plans are a consideration, too. Everything’s changed in the era of tax reform.

Now, there are workarounds in the event the divorce cannot be finalized before year-end, but they are complicated (think “funneling alimony payments through tax-exempt retirement accounts” complicated). It will be far easier to just settle before the end of 2018.

So, should you rush off and get that divorce just to get the tax benefits? No! We would never recommend that. Whenever a family unit separates, in addition to the emotional fallout, the vast majority of individuals (on both sides) do not enjoy the same standard of living once they separate as they did when they were together. Divorce means two households to support with generally less money available to do so. Any talk surrounding divorce should be taken with care with the end goal of preserving family togetherness when possible.

But, if you are heading in that direction, give us a call. We’re well aware of the upcoming changes in tax law that your divorce attorney may not adequately consider. Our goal is to help you select assets and make decisions that will provide you an income stream to fund the lifestyle you’re currently used to. You can come out okay in a divorce. We’ll help you do it.

 

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