Congress passed the Tax Cuts and Jobs Act on December 20, 2017. As a result of this new law, married couples who are considering divorce need to be aware of the 2019 change regarding the deductibility of alimony. This is especially true for those who are considering contractual alimony as part of their divorce settlement agreement..
Texas has very limited spousal maintenance by statute. Except under special circumstances not discussed in this blog, the amount of support is capped at 20% of the payor’s gross monthly income or $5,000 per month. Marriages lasting at least 10 years but less than 20 are limited to 5 years of spousal maintenance; marriages lasting at least 20, but less than 30 are limited to 7 years of spousal maintenance; and marriages longer than 30 years are limited to 10 years of spousal maintenance.
Contractual alimony has been long-standing part of a Texas divorce attorney’s toolkit to use in marriages where there is a high earning spouse and a lower earning spouse. The tax law, up until December 31, 2018, allows the high earning spouse to deduct alimony payments at his/her tax rate. If the high earning spouse’s tax rate is 35%, then the payments actually cost the spouse 65% of the amount paid. The lower earning spouse pays tax on the gross amount of alimony received from the higher earning spouse. If the lower earning spouse’s tax rate is 28%, or lower, then there are net savings that are due to the difference in the tax rates of the individuals. The former spouses get a tax savings of the difference between the high earner’s rate of 35% and the lower earner’s rate of 28%, for a net tax savings of 7% from the U.S. Treasury.
Here are the changes you can expect from this new tax law and how it may affect your divorce settlement if you are considering divorce in Texas.
How Will The New Tax Law Affect Alimony Payments?
Under the Tax Cuts and Jobs Act, divorced taxpayers who divorce after December 31, 2018, will no longer be able to deduct those payments from their taxable income. Recipients of spousal maintenance or contractual alimony will no longer be required to pay taxes on the amount received. However, this new tax law will only apply to those couples who finalize their divorce after December 31, 2018.
This tax law change has the potential to change the amount of contractual alimony that might be offered as a potential settlement tool. Removing contractual alimony from high earner divorces may lead to smaller offers of contractual alimony. Also, there may be more reliance on more traditional divisions of property that involve giving more property to the lower earning spouse rather than a stream of contractual alimony. These assets may require management to ensure a strong, even cash-flow that the lower earning spouse might prefer. The lower-earning spouse may not have the skill set to manage certain types of assets, and will need to pay for professional management. Contractual alimony is secured by a “contract” and is enforceable through the court system as a contract. If traditional property fails to perform (i.e., stock options, real estate, or closely held businesses) the receiving spouse assumes the liability for low or non-performing assets.
The tax-law change could make ending marriage a longer and more expensive process due to how effective alimony traditionally is used in divorce negotiations. Unfortunately, this change may make negotiations of property settlements more difficult, depending on the make-up of the marital estate. When a major marital estate asset is a closely held company that depends on the high earning spouse for value and viability, or when a marital estate has a large debt component, finding a way to divide the property will become more difficult.
Any alimony paid from a final order prior to January 1, 2019 will remain deductible by the payor and taxable to the payee.
Are You Planning on Getting Divorced?
The new tax law change ending the alimony deduction will not affect you if you are currently receiving or paying alimony. However, if you are considering a divorce, we recommend consulting with the divorce lawyers at Vaught Law Firm as soon as possible. They’ll be able to explain your rights during a divorce and what options you have available for your unique situation. Schedule your confidential consultation today.