We have tracked the progress of the current tax reform proposal as it moves through Congress. The House version of the bill had eliminated the alimony (maintenance) deduction as a means to help pay for the reduction in tax rates. The Senate version of the bill kept the maintenance deduction.
After conferencing, the current bill that will be debated and perhaps voted on this week will eliminate the maintenance deduction, but will not take effect until January 1, 2019. Further, it will only apply to new judgments entered on or after January 1, 2019 – meaning that all current maintenance obligors are grandfathered in and can continue the deduction until the obligation ends. Critically, the bill states that modifications entered after the effective date of judgments entered before the effective date do not end the deduction unless the “modification expressly provides that the amendments…apply to such modification.”
What does this mean for maintenance if passed this week?
Because the payor of maintenance has no ability to deduct the amount of maintenance, the change has the effect of shrinking the total income available between the parties to divide at the time of divorce. For example, if a spouse is ordered to pay $1,000 per month and has an annual salary of $100,000, the $12,000 in maintenance currently would be deductible, resulting in a tax savings of roughly $3,000, equivalent to the tax not paid on that $12,000 in income. For those who pay a higher tax bracket, the savings would be as high as 39%, and for those at a lower bracket perhaps only 20% — but still it expands the total marital income. Having that $3,000 to work with in a settlement allows parties to help the recipient spouse receive more in maintenance. But after the new law takes effect, that wiggle room will no longer exist and more spouses will resist agreeing to maintenance awards sufficient to meet the reasonable needs of the recipient spouse.
The real unknown factor in this change will be the impact it has on judges who must decide whether to order maintenance in contested cases. Will the judge consider the impact of the elimination of the tax deduction? One way other provisions of the law balance out the problem is with the expanded child care tax credit, the larger standard deduction and the reduction in marginal tax rates. For some recipient spouses where maintenance will make up the majority of income, they will pay less tax than before the new law. Lawyers working on settlement agreements could calculate the tax savings in that regard and use it to reduce total maintenance paid – in effect transferring the tax savings on the recipient end back to the obligor spouse in an attempt to reach an agreement.
As you can see, the larger the maintenance award, the higher the impact of the change in the law and the more important it will be to identify the cost of the change in negotiating any divorce settlement.
We will continue to keep you up to date on the latest developments.
If you have questions about maintenance and the new tax law, contact us –we can help.