People typically rush into marriage, not divorces. But a curious change in the GOP’s tax bill means that some couples — or individuals — might rush back to the courthouse.
The GOP tax bill signed by Trump late last year fundamentally altered many aspects of the tax code, sending accountants scrambling, and stands as the biggest change to the tax system since 1986. Despite long-standing calls to address the federal debt, the tax cuts outlined in the bill came out to be pricey, projected to cost $1.5 trillion or more, with insufficient revenue gains to pay for it.
One way the Republican bill writers tried to raise revenue to compensate for the cuts was through alimony. Under the new bill, alimony paid by one spouse to the other will not be tax deductible, and the spouse receiving the alimony no longer has to pay taxes on it. In the current system, it works the opposite way, with the payer deducting the full amount and the recipient paying taxes on the alimony at a rate of 15%. The new rule means the government will end up with more of a divorcing pair’s combined money.
When news dropped that this might be included in the bill in November, things got crazy.
“When everyone thought the deduction deadline was going to be Dec. 31, we had a rush of clients,” said Madeline Marzano-Lesnevich, president of the American Academy of Matrimonial Lawyers. “All of a sudden we had clients who were going to be receiving alimony demanding we get them divorced immediately.”
Ultimately the law won’t take effect until next year, giving divorcing couples a reprieve. But the law does set up 2018 to potentially be a wild year for divorces.
“Under the new tax bill, things are going to change somewhat drastically and it’s difficult to predict how it’s going to affect parties,” Sheera Gefen, a divorce attorney in New York, told Yahoo Finance.
It almost sounds like the plot of a Coen brothers movie. In some states, the alimony-seeking spouse may have significant incentive to delay the divorce settlement in order to get the tax benefit in 2019. Meanwhile, the alimony-paying spouse could try to rush it through so they could secure a deduction. What could go wrong?
Divorces could get a lot messier
Potentially, a lot.
Attorneys like Gefen and Marzano-Lesnevich will likely have a much harder time keeping things civil and amicable in divorce disputes, because the alimony payer isn’t only going to have to pay, but will also lose a key deduction.
“The payer spouse could potentially suffer a much higher financial burden and that’ll make settlement discussions more difficult, more difficult to swallow,” said Gefen. “I think it’s going to cause more fights — and tension between attorneys.”
Perhaps the largest and most uncomfortable tension will stem from timing. One side could be dragging its feet in an attempt to delay, and the other will be trying to get a deal signed before New Year’s.
“Depending on who you’re representing you might want to drag it out,” said Gefen. “I’m either going to likely attempt to expedite settlement of global negotiation, or I might want to delay the ultimate.”
This isn’t so in call cases. In states like New York, there’s a formula for calculating appropriate payments and less leeway for negotiations, so timing may be critical. But for some other states, it’s an open negotiation.
“Every state is different,” said Marzano-Lesnevich. In states like New Jersey, without a formula, there is considerable incentive for both parties to hustle because the receiving spouse will end up netting less income for a similar out-of-pocket expense from the paying spouse.
An example of the change
Marzano-Lesnevich illustrated what it’d be like, using a wealthy client as an example. Under the old system, if a highest-tax bracket, soon-to-be ex spouse was set to pay $100,000 per year in alimony, they would get a deduction off the top — at the highest tax rate of around 40% — so they would only be out around $60,000. The recipient would end up with $85,000 after paying a 15% rate on that $100,000.
For couples divorcing in 2019, if the wealthier spouse paid $60,000 — the same out-of-pocket cost as the example above (they’d have less money without the deduction) — the other spouse would only get $60,000.
“We’re shifting the tax, and it’s not to the detriment of the person receiving the money,” said Marzano-Lesnevich.
But it’s likely many couples will try to figure things out, because many spouses would rather see more money go to the family members than the government, Marzano-Lesnevich said. And, of course, a fast divorce means lower legal expenses. According to Gefen, uncontested divorces can be resolved in under a year, so there is hope.
This isn’t just a 2018 problem
But the problem won’t go away in 2019 when the law takes effect. States usually use formulas to calculate alimony payment amounts, and there is no guarantee they will change the laws any time soon, Gefen said.
In New York, for example, the formula factors in tax deductibility for the payor. Judges and courts generally have broad leeway to deviate from the formula if they see fit and to establish payment amounts to account for increased take-home income for the receiver and increased costs for the payer. The legal standard in many states, like New York for example, is whether something is “unjust and inappropriate.” Gefen expects many attorneys to argue this until the formula changes (if it changes).
There’s no guarantee that this gambit works, however. Judges, unlike written laws, are humans, and it’s very difficult to predict how all of them will deal with the changes.
“I do predict some judges will compensate for changes in tax law,” said Gefen. “I also predict others won’t. That’s going to be another source of tension.”
Another large shadow is cast by the new system, one that helped lead the American Association of Matrimonial Lawyers to oppose the new law, despite the conventional wisdom that a long divorce is good for lawyers. Less money to share means that for lower-income divorces, financial constraints may trap people in bad marriages.
“This is going to result in uncomfortable settlement talks, and it might result in hostility between parties,” said Gefen. “So overall I don’t see this as a good thing.”
As for the rush? Marzano-Lesnevich said it’s died down slightly — for now: “I would predict come November, December we’ll have the same rush.”
Ethan Wolff-Mann is a writer at Yahoo Finance. Follow him on Twitter@ewolffmann. Confidential tip line: FinanceTips[at]oath[.com].
