As of January 1st, 2019, under the new Tax Justice Reform Act of 2017, alimony payments are no longer deductible from the payor’s taxes, nor taxable to the recipient. This means that alimony is paid from after-tax income, and is therefore most costly to the payor, but that the recipient enjoys the benefit of untaxed income. Theoretically recipients should now require a lower level of alimony to meet their household budgets, and higher earning payors presumably taxed at a higher level will have less money after paying alimony and child support to meet their own expenses. Unfortunately, elimination of this tax loophole generates more taxes for IRS and state tax authorities, leaving the post-divorce family with less money to meet their increased separate expenses. For this reason, many clients and their lawyers were scrambling to negotiate divorce agreements before the January 1st deadline, although many unresolved cases remain to be settled under the changed rules.
In my experience, some lawyers have not yet educated their clients nor adjusted their negotiations to reflect the reality that lower alimony will generally satisfy the dependent spouse’s living expenses, and that alimony at conventional levels may be unsustainable for the payor. In addition to the dependent spouse’s budgetary needs, the payor’s ability to pay has always been a factor in judicial alimony determinations. But lawyers are generally not trained to calculate the after-tax consequences of alimony to spouses in different tax brackets. Lawyers may not trust referring clients to CPAs or other financial professionals to calculate budgeted tax projections for 5 – 10 years in the future, nor be competent to use available software to model such projections. In the worst circumstances, lawyers ‘game’ alimony negotiations in the absence of quantifiable net income projections.
Principled alimony and child support negotiations start from negotiating realistic post-divorce household budgets, which the parties are best capable of doing, sometimes with the assistance of a neutral financial professional in collaborate negotiations, or separate professionals in contested negotiations. From this basis, tax projections based on the payor’s higher-taxed ‘Single’ filing status (with a lower standard deduction) relative to the recipient’s lower-taxed ‘Head of Household’ filing status (with a higher standard deduction, and perhaps non-refundable Child Tax Credits in lieu of suspended child tax exemptions), offer insight into income constraints that should motivate reconsideration of traditional spending patterns. (For example, there may not be sufficient income for each parent to enjoy separate week-long vacations with children if a one-week family vacation was previously their norm.) Adjusting to the ‘new normal’ spending after divorce is often an obstacle to achieving agreement, resulting in protracted and unnecessarily costly negotiations.
Although alimony and child support are now both non-taxable, well advised negotiating parties are mindful that the reduction and eventual expiration of child support as children ‘age out’ of the household may leave the dependent spouse with insufficient or excess alimony to meet his or her living expenses. In Maryland and the District of Columbia, indefinite alimony is rare, and alimony is awarded on a time-limited basis to enable the dependent spouse to re-establish him or herself as self-supporting. Accordingly, alimony may persist after child support terminates, sometimes well beyond a reasonable period to transition to entire self-reliance.
Fair alimony is designed to redress the imbalance of earning capacity that results from a couple’s decision that a ‘caretaker’ spouse withdraw from the workforce to manage children and the household, relying on the higher earning ‘breadwinner’ spouse’s income. Withdrawal from the workforce for even a few years may impair the dependent spouse’s ability to support him or herself, even if the dependent spouse formerly earned a comparable salary. Alimony recognizes the implicit ‘contract’ between spouses that would be breached if this imbalance were not redressed. If you are uncertain how much alimony is reasonable to pay or receive after divorce, consult a lawyer capable of estimating the tax impacts to the parties to establish a principled basis for alimony negotiations.