Sep 26

The 2018 Tax Law Changes Divorce Rules

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Unless you’ve been living under a rock, you know that Congress recently passed a new tax law that President Trump enthusiastically signed. This new tax law, called the Tax Cuts and Jobs Act of 2018, or TCJA, affects everyone in some way. Some of the effects will be a surprise for some people, as they received little to no media attention.
The change in the tax law that I want to discuss with you today concerns the impact the TCJA will have on alimony, or what we in Wisconsin call maintenance. The changes will go into effect in 2019, so for now we’re still operating under the old law. If you are divorced, there is a good chance that you are either paying or receiving maintenance. Under the current rules, if you’re paying maintenance you can deduct your payments directly from your taxable income. This is called an “above line” deduction because it reduces your income before applying either the itemized or standardized deduction to your gross income. Likewise, if you’re receiving maintenance, the current law requires that you include those payments as regular income on your 1040 and pay income taxes on that amount.
Effective in 2019, for all divorce agreements signed after December 31, 2018, maintenance payments will no longer be deductible for the payor or includible as income for the payee. In other words, the tax code will treat maintenance payments as they now treat child support payments, as those are neither deductible for the payor or taxable to the payee. Note that I said that this change will affect agreements signed after December 31, 2018. Any agreements signed before the end of this year will be grandfathered in under the current law.
I know what you might be thinking if you’re already divorced: since my agreement won’t be affected, why should I care? I’m glad you asked, because you could still be affected by the changes in the law. For example, perhaps your agreement requires annual adjustments so that you and your ex will have the same after-tax income. Maybe your agreement considers the child tax credit deduction as part of its formula to equalize your income. The TCJA eliminates personal exemptions, doubles the standard deduction, expands the child tax credit and reconfigures the tax rates. The impact of those changes could subvert your divorce agreement and result in unintended consequences for both you and your ex.
Suppose you are paying child support and maintenance to your former spouse such that under the current law you and your ex end the year with about the same amount of spendable (after tax) income just as your agreement intended. However, let’s also say that your wage income is at least $85,000.00 while your former spouse earns around $25,000.00. After applying the new tax brackets and doubling the standard deduction, there is a very real probability that together you and your ex will enjoy total tax savings of between $4,000 and $5,000, which sounds great. However, those savings will not be applied equally: as the higher income earner, you will receive about twice the savings that your ex will receive, such that your after-tax income will be somewhere around $2,000 per year more than theirs. If your agreement requires annual adjustments to keep your incomes equalized, you will have a problem.
Here’s another scenario: suppose it’s 2019 or later and you or your former spouse want to make some changes to your divorce agreement. It happens a lot more often than people think. I have
represented almost as many clients regarding post judgment matters as I have those involved in a divorce. This scenario involves good news and bad news. The good news if you’re paying maintenance is that you can keep deducting your payments. The bad news if you’re the one receiving maintenance, is you would keep claiming it as income. However, the bad news for both of you is that because of the other changes the TCJA implements regarding the adjustment of tax brackets, etc., you will run into the issue I described in the previous paragraph, which could strain the negotiations between you and your ex. Unless your new agreement specifically says that it is subject to the terms of the TCJA it would remain governed by the old law, but the new tax brackets. So, either way, you would be potentially walking into a storm.
One of you may want to take advantage of the non-taxable receipt of maintenance while the other may want to keep deducting those payments from their income. This could set up a potential war between you. I anticipate that the Court of Appeals and Wisconsin Supreme Court will eventually have to decide what to do in this situation. It will likely take some time before the courts settle on a way to resolve these disputes, which means that in the meantime we could see several different outcomes depending on how trial court judges struggle to deal with this.
At first glance, it may appear that the changes to the tax law benefit the person receiving maintenance because they will no longer claim it as income. However, it may not turn out that way in practice. Consider this scenario: A earns $100,000 per year and B earns $30,000. Under current law A would pay $31,224 to B as maintenance, which would result in equal spendable income for both. A agrees to this because the reduction in A’s taxable income by over $31,000 enables him or her to afford the payments. However, if A and B divorce in 2019, A could legitimately argue that he or she could not afford to pay B $31,224 and could only afford to pay around half that amount. Even after calculating the non-taxability of the approximately $16,000 that A would now pay, at the end of the day B would have less spendable income than under the current law.
If you aren’t divorced, but you’re contemplating ending your marriage, then you may want to consider the potential effects of the TCJA. Even if you divorce in 2018, the new law could impact the feasibility of your agreement in subsequent years as the tax brackets and deductions change. At the very least, if you want to lock in the deductibility of your maintenance payments, then you would have to divorce in 2018. If you’re the one who would likely receive maintenance, then you may want to wait until 2019 to finalize your divorce. Even if you do not care when you divorce, the new tax law will affect the calculations underlying any agreement that you and your ex will make.
In short, things just became a lot more complicated. One of my concerns is that people who pursue their divorce without legal counsel will unwittingly find themselves facing divorce related tax scenarios that will overwhelm them. Divorce is already complicated enough, and in my opinion Congress did us no favors when they decided to change the tax laws without thinking through all the potential impacts of those changes. My colleagues and I, along with our trial judges, will be the ones left to figure out how to navigate through these choppy waters

Alf Langan

Solo practitioner attorney since 1991 based in Green Bay, Wisconsin, specializing in estate planning, family law, and criminal defense. B.A. from Northwestern University: J.D. from St. Louis University School of Law. Licensed to practice in Wisconsin, Illinois, U.S. Tax Court, U.S. Federal District Court (E.D., Wisconsin).