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Divorce under the New Tax Code

August 13, 2018

Divorce can be a messy and hard-to-negotiate process, and the recently passed Tax Cuts and Jobs Act may make that process even more difficult for couples with its abolishment of tax deductions on alimony payments.  Before the TCJA, alimony payers could deduct payments that met the tax-law definition of alimony for federal income tax purpose, and alimony payment recipients always had to pay income tax on those payments.  Now, for alimony payments required under divorce or separation instruments that are executed after December 31st, 2018, the deduction will be eliminated, and recipients of the affected payments will no longer have to include them as taxable income. With December 31st looming on the not-so-distant horizon, the pressure will be on some divorcing couples to finalize their divorces before the new rules on alimony deductions take effect in 2019, but for others, delaying a divorce until the new law takes effect may prove more beneficial.

The changes in the tax law are leading spouses who are going through a divorce to look more closely at the values of privately owned business as well as benefits for their children.  The values of private businesses may present a reason to delay a divorce.  The new tax law increases the cash flow of certain businesses where the taxes on earnings are paid by the owner rather than the company, which raises the business’s value.  Because a business is often the most disputed asset in a divorce, any question as to the business’s value may serve to complicate divorce negotiations.  To create further uncertainty, business owners will not realize any higher cash flow resulting from the change in the tax law until he or she files a tax return next year.  The fact that several numbers—including child support, which is generally negotiated only once—are derived from the value of a private business makes correctly determining the value of that business all the more important.  As a result, it might be a good idea for couples who are expecting a big increase in the value of their business next year to delay a divorce. 

Couples should consider how the values of other assets may change under the new tax code.  For example, the tax changes may make a family home less valuable in the long term than a similarly valued retirement account.  The spouse who chooses the retirement account over the house can avoid paying property taxes and will also be more financially secure in their later years.  In addition, under the new tax code, 529 savings plans, which were previously limited to post-secondary education, can be used to pay for private school for children.  While this change can help with early school costs, it may also lead to a lack of money left over the pay for college, and spouses will need to ensure that they do not count the assets in a 529 plan toward their contribution to school or college.

The change in the tax code may also result in further consequences that will make divorce more difficult.  Many predict that divorces may become messier, as an offer of tax relief to alimony payers, which often helps to move negotiations forward, will no longer be possible.  Because lawyers can no longer use tax relief as a tool for settling cases outside of the court system, more divorce cases may go to trial.  In addition, the elimination of the tax benefit may make divorce more expensive.  Under the old code, a household’s higher-paid earner, who would typically have a bigger tax bill, transfers income to the lower-paid earner, who may have a smaller tax burden, resulting in tax relief to the household.  Without the tax benefit, some couples may not be able to afford a divorce, and instead choose to stay together.  Overall, couples seeking a divorce will need to closely examine their finances to determine whether they should hurry to get a divorce before December 31st or whether they should wait to ensure maximum benefits.