Don’t let the new divorce tax rules leave you with a big financial disadvantage
The War of the Roses could continue indefinitely.
And one key deadline could force couples to come to an agreement before the end of the year.
Dec. 31, 2018 is the date by which couples need to get the terms of their divorce settled before the tax rules on alimony change, a result of the Tax Cuts and Jobs Act that was passed last year.
Under current rules, alimony payments are tax-deductible for the payor and taxable income for the payee. Once the clock strikes 2019, however, those rules no longer apply.
This change upends alimony procedures that have been in place for more than 70 years. And it is projected to raise $6.9 billion for the IRS in the next 10 years.
Divorce professionals are feeling the heat as couples scramble to get written agreements in under the wire.
“You’ve got to have a signed agreement before the end of the year if you want your permanent support to be tax-deductible and -includable,” said Peter M. Walzer, president of the American Academy of Matrimonial Lawyers.
Once the page of the calendar turns to 2019, it will be a new playing field for couples who are divorcing.
And financial professionals are already concerned that deals made under the new tax law will put the person who receives alimony at a disadvantage. That means women, who are already more financially vulnerable in a divorce, might have less money to work with post-split.
Research has found that women generally fare worse financially after a divorce. Their income typically falls by more than a fifth, while men who have children often see their earnings rise by a third, according to research by professor Stephen Jenkins of the London School of Economics.
And the stakes for women may, in the end, be even higher with the changing alimony tax rules.
Financial advisor Stacy Francis, president and CEO of Francis Financial, said she has received many calls and emails from women celebrating the change. After all, if you’re receiving $3,000 a month in alimony and that’s no longer taxable, that could be a great thing.
However, “even though that dollar amount you receive in alimony might not be taxable to you any longer, most likely the amount that’s going to be paid to you is a whole lot less,” Francis said. “There is going to be fewer dollars available for that alimony and also child support.”
While more women today are serving as household breadwinners, and possibly paying spousal support, alimony recipients are still mostly women. Data from the 2010 Census show that of about 400,000 alimony recipients, 3 percent were men.
Once the new tax rules take effect, “women are expected to suffer most,” Francis said.
One divorce calculator shows that there could be less money to go around after the new tax rules go into effect — resulting in smaller alimony payments.
That is according to Analyze My Divorce Settlement, the latest tool from Boston University economics professor Laurence Kotlikoff’s company, Economic Security Planning.
“They do have to adjust the alimony amount in light of the change in the law,” Kotlikoff said. “It can be a dramatic adjustment.”
A hypothetical scenario run through the tool takes one couple who are both 50 and living in Colorado with no children. After splitting $1.5 million in savings and selling their house for $1 million, they both rent for $2,500 a month.
The goal of their divorce is to keep their living standard equal, according to Analyze My Divorce Settlement’s assumptions. So the husband making $500,000 will pay alimony payments to the wife, who makes $50,000 a year.
If the couple divorces in 2018, alimony payments of $230,000 per year until 2033 would result in discretionary spending of about $86,000 per year for each spouse, according to the calculator.
Discretionary spending is what each person is left with after housing, taxes and other expenses including alimony.
But once those alimony payments become non-tax related in 2019, payments of the same amount would dramatically change the amount of money available to the couple.
The husband making the payments would have $50,660 in discretionary spending, while the wife receiving the money would have $122,403.
By reducing those alimony payments to $138,200, the couple would once again each have about $86,000 per year in discretionary spending.
“These results are extremely striking,” Kotlikoff said. “We’re talking about the appropriate amount of alimony being dramatically smaller due to this tax reform.”
The goal is to make both spouses’ living standard equal. “We’re not siding with the male,” Kotlikoff said. “This is coming from academia.”
The lesson from this is that couples — and courts, lawyers and mediators — need to be adjusting how they split alimony in light of this, according to Kotlikoff.
“The whole mindset has to change,” Kotlikoff said.
One big question is how prenuptial and postnuptial agreements that were completed before the new tax law went into effect will be treated.
“This is the reality TV portion of the Trump tax reform,” Francis said. “We are going to have revenue rulings that will help guide us, but we don’t have them yet.”
Walzer said his practice is currently dealing with a couple with a preexisting premarital agreement that stipulated spousal support would be capped at $5,000 a month.
Now that the couple is entering into divorce proceedings, it remains to be seen how the court will treat that deal. The court could decide $5,000 is the cap of non-deductible dollars, or it could reduce it because there’s no longer a deduction.
Walzer and his partner disagreed on what the outcome will be. He thinks the court wouldn’t reduce it, while his partner thinks it will.
Those questions will be sorted out in time.
In the meantime, the best move to make — whether you have a prenup, postnup or are already divorced — is to revisit your agreement with a CPA or tax or divorce attorney, said Megan Gorman, managing partner at Chequers Financial Management.
“The rules of the game are not the same,” Gorman said. “You need to make sure that your legal agreements are in alignment.”
The bottom line for all couples going through the divorce process: Seek professional help.
“I’ve talked to a lot of people who say, ‘Well, I’m just going to represent myself,'” said Russ Thornton, financial advisor at Wealthcare for Women. “There’s a lot of benefits to seeking the help and guidance of a family law attorney, even if you and your spouse want to draft your own agreement and present yourself in court.”
Tools such as Analyze My Divorce can also help couples assess the impact of how they divide their assets. The software is available for $99 per year for individuals and $399 for professionals.