The final months of 2017 saw Congress pass widely publicized legislation promising broad-based reform of the federal tax system. The final measure[1] – which is due to be signed by the President prior to the upcoming holiday recess – reflects a consensus between sweeping changes proposed by the House and a more moderate counterproposal offered by the Senate. Provisions eliminating the taxation and tax-deductibility of alimony payments[2] and lowering the mortgage interest deduction cap[3] mean the substantial impact predicted for the public and private sectors[4] is likely to also be felt by couples going through divorce. For those of you contemplating or currently pursuing a divorce, here are the two main ways the new legislation may affect you:
Alimony. Under the present system, alimony payments (referred to under California law as spousal support) are treated as taxable income for the recipient spouse, and tax-deductible income for the paying spouse.[5] Take, for example, Spouse A (who earns $500,000 per year) and Spouse B (who earns $0). During their divorce proceedings, the court orders Spouse A to pay Spouse B $175,000 a year in alimony. Spouse A is currently allowed to deduct this $175,000 from their taxable income, while Spouse B has a baseline taxable income of $175,000. Under the new legislation, alimony is neither tax-deductible for the payor, nor taxable for the payee.[6] Because their alimony payments are not considered taxable, Spouse B would receive $175,000 tax-free, while Spouse A would pay $175,000 from their post-tax income. The new legislation will not come into effect until January 1, 2019, so only couples who execute or modify their divorce decrees after December 31, 2018 will be impacted. While the law as currently applied arguably incentivizes an accelerated settlement process by providing a tax break to payors of spousal support, the new law risks creating a disincentive for individuals to settle to spousal support disputes. Since spousal support is a common point of negotiation between divorcing couples, increased contention on this point risks prolonging the settlement process, resulting in a higher emotional and financial costs for the couple, and a negative impact on judicial economy.
Mortgage Interest Deduction. Currently, the tax code allows homeowners to deduct interest on the first $1 million of a new mortgage. Congress has imposed a temporary lowering of this cap to $750,000 through the end of 2025.[7] While this won’t affect divorcing couples who already have a mortgage (current mortgages are grandfathered in to the current $1 million cap), couples who obtain a mortgage after the passage of this new legislation and later decide to get divorced may be impacted. According to the California Family Code, the statewide uniform guide for determining child support takes into consideration the “state and federal income tax liability resulting from the parties’ taxable income […] after considering appropriate filing status, all available exclusions, deductions, and credits.”[8] Spousal support is also a function of the net disposable income of both parties. Therefore, if the deduction cap is lowered, it may result in the payor being able to deduct less from their taxable income under the compromised plan, giving them less net disposable income, and reducing the amount of support received by the payee.
In light of the passage of this new legislation, it is critical to stay on top of the constantly changing legal landscape. Couples undergoing a divorce deserve a law firm with a team of experienced experts to explain how the changing tax code may impact the trajectory of their divorce. At the Law Offices of Diana P. Zitser, our network of brokers, appraisers, forensic accountants, and other tax professionals can provide this invaluable insight. For more information on how current legislative trends could affect your divorce proceeding, schedule a consult with our offices by visiting our website, or calling us at (818) 763-5274.
[1] Jeanne Sahadi, What’s in the GOP’s Final Tax Plan, CNN Money (Dec. 20, 2017, 8:21 AM), http://money.cnn.com/2017/12/15/news/economy/gop-tax-plan-details.
[2] Alexis Leondis, Why You Don’t Have to Rush to Get a Divorce Before 2018, Bloomberg Politics (Dec. 18, 2017, 7:37 AM), https://www.bloomberg.com/news/articles/2017-12-18.
[3] Darla Mercado, Here Are Five Breaks You’ll Miss the Most in the Tax Bill, CNBC (Dec. 19, 2017, 9:24 AM) https://www.cnbc.com/2017/12/19.
[4] John W. Schoen, GOP Plan Would Stick Millions with Bigger Tax Bills, CNBC (Dec. 12, 2017, 2:28 PM) https://www.cnbc.com/2017/12/12.
[5] Mercado, supra note 3.
[6] Leondis, supra note 2.
[7] Mercado, supra note 3.
[8] Cal. Fam. Code, § 4055 et seq.
