Published as part of the sponsored “2018 Law Journal” section in the September issue.
[/media-credit] J. Gregory Hatcher
J. Gregory Hatcher
Hatcher Law Group
The terms alimony, spousal support, and alimony typically refer to money paid by one separated spouse to another in a specific amount over a specific period of time. This is not child support, but rather support that allows the receiving spouse to maintain the standard of living achieved during the marriage and also to pay for certain expenses that he or she would otherwise not be able to afford without the help of the other spouse. Hundreds of thousands of Americans pay child support every year. Under the 75-year-old federal law, alimony payments are deductible from the paying spouse's gross income, while the receiving spouse must report the payments as taxable income. The purpose of the tax break is to fill the financial gap caused by the separation of spouses and the creation of two households. Recent tax changes will determine whether and how many spouses will receive maintenance in the future. In order to receive a tax deduction for alimony payments, the spouses must either enter into a signed agreement on alimony or have an order regulating the alimony before January 1, 2019. As a result, family law attorneys are scrambling to help their clients resolve child support claims before the end of the year. At this point, they lose a valuable tool they have relied on to reach an agreement and help their clients achieve their financial goals.
This is how it works under our current tax law.
In North Carolina, only a spouse who makes more money than the other spouse can be required to pay alimony. As a result, the spouse receiving the alimony is typically in a much lower tax bracket, so the alimony received is taxed at a much lower rate than if it had simply remained as income to the paying spouse. Under our current tax code, support amounts can be expanded even further by the tax deduction available to the supporting spouse. For example, if the dependent spouse has $6,000 per month available to pay support to the dependent spouse ($72,000 per year), but the dependent spouse has $8,333 per month in support ($100,000 per year). ) is needed, current tax law allows the supporting spouse to adjust their withholdings and typically reach the support goal of $8,333 per month. The dependent spouse could rely on the tax deduction to “find” more money after taxes to pay the dependent spouse.
Justification for the changes to the tax code.
In 2017, the government introduced a comprehensive tax reform that included the abolition of the alimony deduction. The Joint Committee on Taxation believed that divorcing Americans would have an advantage over married Americans through a so-called “divorce allowance.” The divorce allowance is formed as follows: The husband pays the wife $100,000 a year in maintenance. The husband is entitled to adjust his gross income by taking a $100,000 deduction for alimony he paid that year. Because of his presumably high tax bracket, the husband is expected to save $50,000 in taxes. The wife, on the other hand, reports the $100,000 in alimony she received as income, but only pays $20,000 in taxes due to her low tax bracket. The net difference is $30,000 between what the husband saved and what the wife paid. The government lost $30,000 in taxpayer money. Therefore, the federal government viewed this tax break as ripe for elimination as part of its efforts to reduce the federal deficit. It was argued that eliminating the alimony tax deduction would increase federal revenue by $7 billion over ten years. However, it is important to realize that the alleged $7 billion in savings amounts to less than half a percent of the current federal deficit. It is also important to consider the impact on the parties when divorcing couples attempt to negotiate an agreement without this tax deduction.
The reality of tax is changing. Like between spouses.
Some may initially believe that the new tax law will benefit the alimony recipient. Finally, the receiving spouse no longer has to claim the alimony payments as taxable income, which is likely to result in a higher alimony payment for the spouse entitled to the alimony. However, the opposite is probably true. Supportive spouses will negotiate harder for a lower alimony amount. Lawyers will no longer be able to find money to pay for the additional support needed. The litigation will likely escalate and both parties will incur higher fees. Even after the parties agree on an amount or a judge orders it, the impact on the receiving spouse remains. Taking the example above of a dependent spouse requiring $8,333 in support per month, the dependent spouse now only has $6,000 available to pay the dependent spouse. The dependent spouse receives $27,996 less in support. The support spouse is already in a lower tax bracket than the support spouse, so the loss of total support is likely greater than the benefit of making the support non-taxable. The decline in total support amounts will be exacerbated by future reductions in child support. It often happens that spouses who receive maintenance remain at home as parents during the marriage and receive maintenance for the children after the parties separate. Although child support is not taxable, in North Carolina the obligation to pay typically ends when the child graduates from high school or turns 18, whichever is later. If alimony isn't enough, spousal support can help pay the bills. However, if the same spouse receives less child support to begin with, he or she will be doubly damaged when child support ends.
Pre- and post-nuptial agreements.
A prenuptial agreement is entered into by parties who wish to marry. A prenuptial agreement is entered into by parties who are already married but not yet separated. Both types of agreements are intended to resolve future issues between the parties, such as property division and support obligations. Because current tax law has been in effect for 75 years, most pre- and post-nuptial agreements were likely based on the assumption that alimony would be taxable to the receiving spouse and deductible to the paying spouse. No statement from the IRS addressed the impact of the new tax law on these arrangements or any future changes under the new tax law. There are significant questions as to whether these arrangements would meet the IRS Code requirements for alimony to be tax effective under our current law. No party to such an agreement should wish to be the test case to the IRS or any other government agency on these issues.
What to do? Be proactive.
• Spouses who expect to separate in the near future should consult a family law attorney immediately to determine how the new tax law will affect their case. Speak with your tax professional or divorce planner and your family law attorney to calculate the actual tax implications for the paying and receiving spouses. Also, confirm that your settlement agreement or order complies with the requirements of the new tax legislation.
• Spouses who are already separated should make every effort to resolve maintenance claims on a permanent basis before the end of 2018 and before the court docket is full.
• Don't make assumptions. There is no indication that parties whose temporary alimony filings were filed in 2018 will receive current tax benefits for permanent alimony filings filed after 2018.
• If you have a prenuptial or postnuptial agreement that was created without reference to the new tax laws, contact a family law attorney to discuss revisions and possible renegotiation. Remember that both the payer and the payee have incentives to avoid the effects of the new tax law. If you are happily married, the renegotiation can go smoothly.
J. Gregory Hatcher is a managing partner at Hatcher Law Group, PC, who has dedicated nearly 25 years to representing clients in complex family law matters. He is a Fellow of the American Academy of MatrimonialLawyers and a certified family law attorney by the North Carolina State Bar. Greg has received peer and industry recognition, including awards such as North Carolina Super Lawyers, Legal Elite in Family Law from Business North Carolina magazine, and AV Preeminent Peer Review Rating from Martindale-Hubbell.
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