Shortly before year-end, President Trump signed the “2017 Tax Cuts and Jobs Act” into law. As is so often the case in law and government, the text of this 1,000-page law is intimidating. I cannot begin to pretend to be able to fully understand all its ins and outs, nor to explain those to anyone else. I am in particular a family law attorney, not a tax attorney or CPA. Nothing herein should be construed as tax advice, nor as specific legal advice for any one person’s exact situation. This is a template, global overview, which is hopefully helpful to many.
What I can do is offer my best analysis and projection on the most significant impact this will have on divorcing couples, and that is its effect on the tax deductibility of spousal support, also sometimes called “alimony” in some states.
Under Section 11051 of this Act, the Bill includes language eliminating the tax deductibility of spousal support by the payor, and corresponding requirement that it be reported as income by the payee. This had been the tax treatment of spousal support for the last approximately 75 years. This new law does not affect any divorce or separation instrument executed by 12/31/2018. So, we all have this year to figure this out.
Internal Revenue Code Section 71(2) defines a “divorce or separation instrument” as “(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree, (B) a written separation agreement, or (C) a decree requiring a spouse to make payments for the support or maintenance of the other spouse.” The law also provides that orders executed before 12/31/2018, which are modified thereafter, will remain under the old taxability rules unless the modification order specifically states that the new rules will apply to it.
I read the law as intended to apply to any spousal support order executed by 12/31/2018, whether so-called “temporary” or “permanent.” I do, however, see some, slight wiggle-room, and would not be shocked if a court ruled that the order had to be part of a Judgment, as opposed to a temporary order only, to preserve the old taxability rules. Again, I believe such a ruling would be in error, but it would not surprise me. If we start to receive any such errant rulings, they will come in early 2019; someone will have to take them up on appeal, and we may not have appellate guidance on that question until late 2019 or early 2020. The court and legal system is invariably slow to catch up with the times.
So, in theory, any order executed before 12/31/2018 can remain under old taxability rules throughout its life, even if modified later. Although, a complete unknown is how trial courts handling modifications will respond. Will the judges as a matter of course from 1/01/2019 forward start shifting modified orders to the new rules? Parties stipulating to modify their pre-2019 orders may well specifically preserve the tax deductible for payor, taxable to payee rules, in order to maintain what they’re used to. But judges presented with modification requests might change the numbers, and the taxability. Not that my opinion matters, but that’s probably what I would do as a judge.
What is certain is that spousal support analyses in the world of family law must adjust in the months and years to come. The bottom line effect of the changes is that spousal support will become like child support – a non-tax event. This means spousal support will have to be paid out of after-tax monies available to the payor, and then will not be taxable income to the payee. Obviously, someone is always paying the taxes. So, what the new law does is shift the tax burden for spousal support from the payee over to the payor. Invariably, a payor is the higher earner, and most the time will therefore also be in a higher tax bracket.
This means that since payors will have to cover the tax burden on spousal support under the new law, they will have less after-tax income available to do so. Therefore, we can expect spousal support awards to be less. Payees can expect to receive smaller checks. Spousal support is a divvying up of two people’s income available after taxes. With the payor paying the taxes on the support, instead of the payee, there is less in that overall pool to share.
One thing that is certain is that if there exists on file at least some kind of spousal support order before 12/31/2018, there should be more options going forward.
From an abundance of caution, we are proposing language like the following in newly drafted support orders, to try to protect against future changes and uncertainties:
“The payment of spousal support from Payor to Payee shall be tax deductible to the Payor and shall be included as taxable income by the Payee on his/her Federal and State personal income tax returns. This is a critical and material provision, and, is part of each party’s expectations in entering the spousal support order set forth herein. In the event the tax treatment of spousal support contemplated herein is disallowed by any taxing authority, and thereby the parties’ expectations regarding their respective net disposable incomes are not met, this shall be a material change of circumstances warranting modification of this spousal support order. Any such modification, whether by stipulation or contested before a judge, shall be retroactive to whatever extent necessary to address the unmet expectations. Additionally, the Payee shall reimburse the Payor an amount to be determined to fairly adjust any support paid during a period of time for which tax deductibility for the Payor was later disallowed by any taxing authority. The parties shall meet and confer to determine the appropriate adjustment and amount of reimbursement should these circumstances arise, as well as the timing (i.e., lump sum or installments) of reimbursement. The Court reserves jurisdiction to effectuate the terms of this Provision.”
I do advise that you speak with your tax preparer or other tax expert about the foregoing, for tax planning purposes and specific tax advice. If you do not have such a person, please let me know and I’d be happy to refer you to someone who can assist you. Contact me at the San Jose Divorce and Family Law Attorneys of Hoover ♦ Krepelka, LLP.