For the last seventy-five years, a spouse paying alimony (also known as “maintenance” or “spousal support” in New York and many other jurisdictions) has been able to deduct the alimony award from his or her tax return each year. Likewise, the spouse receiving the maintenance has the obligation to include the total amount of alimony received as income on his or her tax return.
This has now changed under H.R.1 – An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, otherwise known as the 2017 Tax Bill. Specifically, under Section 11051 of the 2017 Tax Bill, Repeal of Deduction for Alimony Payments, starting in 2019 alimony will no longer be deductible to the payor spouse. The recipient spouse will no longer pay taxes on the income received as a result of the alimony award. Importantly for matrimonial practitioners and their clients, this change only affects divorces commenced after December 31, 2018.
At first blush, this change might seem to benefit the recipient spouse, who no longer carries the obligation to pay taxes on the additional income. Unfortunately, due to progressive marginal tax rates, this change actually reduces the overall “pot” of money available to the family. For example, if the payor spouse is ordered to pay $60,000.00 per year in alimony, at the highest tax bracket (40%), the effective payment would be $36,000.00 out of pocket (considering the $24,000.00 tax deduction for the payor spouse.) The recipient spouse, paying 15% in income taxes on the alimony award of $60,000.00, nets $51,000.00. However, under the 2017 Tax Bill, the court can only order the payor spouse to pay $36,000.00 in alimony to the recipient spouse if the court desires to maintain the same level of out of pocket expenses for the payor. An award of $60,000.00 could result in an inequitable result to the payor spouse, who now must pay a higher tax burden, in addition to the alimony award. Continuing our example, if the Court seeks to award the recipient spouse $51,000 (the net result under prior law), the payor spouse’s total out of pocket is $51,000 of after tax income, a $15,000 loss to the family unit.
This change will only add an estimated $6.9 billion dollars in new tax revenue over ten years to the federal government, with some estimating that the tax bill will add up to $1.5 trillion dollars to the deficit in the same time period. The burden now shifts to families, who will lose those previously available funds to distribute between the spouses, as well as to states, which will now need to account for the change when determining maintenance awards. New York follows a formula to derive the presumptively correct alimony amount. Presumably, this calculation previously took into consideration the tax implications to each spouse; whether this will now be modified depends on our state legislature. While Governor Cuomo and legislative leaders have been outspoken on SALT deductions, it is unclear if a new alimony formula is currently being discussed or will be implemented by the end of the year. This change will likely be one of many tax law changes to have an effect on settlement negotiations, where under the previous plan, the appeal of a tax deduction was often an incentive for the payor spouse to reach an agreement.
Accountants and attorneys are still figuring out the ways in which the new tax bill affects our clients. It will be an interesting year to come.