The Impact of The New Tax Law on Divorces Part 1: Collecting More Income Tax
Matrimonial law in New York State typically is legislated in Albany. However, this year the biggest change in matrimonial law comes from Washington, D.C. The 2017 “Tax Cuts and Jobs Act” includes among its 186 pages a section entitled “Repeal of Deduction for Alimony Payments.”
This section eliminates the IRS Code provisions that allowed the payor of spousal maintenance to deduct from his or her taxable income any maintenance he or she has paid to his or her spouse or former spouse. This is a radical change from what has been the law since 1942.
There has been some information in the press about the change in the tax deductibility of maintenance and a prediction of a year-end rush for people to complete their divorces. However, very little has been written on what will happen under the new tax law in relation to New York’s Maintenance Guidelines and possible strategies to try to deal with this impact.
This series of posts will (1) discuss the extent of the changes to the Federal tax code and its treatment of spousal maintenance, (2) explore the significant impacts of the new Federal tax code on spousal maintenance and (3) suggest a number of possible strategies to try to deal with this impact.
While the stated purpose for the “Tax Cuts and Jobs Act” is to cut income taxes, streamline the tax code and help promote domestic economic growth, the repeal of the deduction of maintenance payments serves no such purpose. It simply helps the government maximize the amount of income taxes it will collect under the revised tax code.
The new tax code will accomplish this by taxing the entirety of the maintenance payor’s income, including the maintenance he of she will pay, at a tax rate that will be higher than if the maintenance was taxed at the rate of his or her spouse or former spouse. This means more money for the government and less money for the divorced taxpayers.
A quick hypothetical illustration of how this will work should put the gravity of the situation into perspective. Let us assume a husband, who has a taxable income of $150,000 per year, and a wife, who has a taxable income of $25,000, in a childless marriage. Under New York’s Maintenance Guidelines the husband’s presumptive maintenance obligation would be $40,000 per year. Under the current tax law the husband would pay income taxes on his net taxable income of $110,000 while the wife would pay income taxes on her gross taxable income of $65,000.
With this amount of maintenance, the wife would remain in the 12 percent tax bracket, which covers the income range of $19,051 to $77,400. On her $65,000 of taxable income she would pay about $7800 of Federal income tax. Of this, $4800 is a result of the maintenance she receives.
With this amount of maintenance, the husband would remain in the 24 percent tax bracket, which covers the income range of $82,501 to $157,500. Therefore, deducting the $40,000 of maintenance would reduce his income tax liability by $9600. That $40,000 really only cost him $30,400 after taxes. This shifting of taxable income also costs the Federal Government $4800 of income tax.
Using the same numbers for 2019, we get a radically different result. The presumptive maintenance obligation remains $40,000 per year but the husband would pay income taxes on his gross taxable income of $150,000 while the wife would pay income taxes only on her taxable income of $25,000.
Applying the new tax code to these figures, the wife would be in the 12 percent tax bracket. She would pay about $2810 of federal income tax. That is about $5000 less than she would have paid for 2018.
Applying the new tax code to these figures, the husband would be in the 24 percent tax bracket. He would pay about $35,700 of Federal income tax. That’s about $10,000 more than he would have paid for 2018. And the third party in this equation, the Federal government, gets about $5000 more in taxes collected. This, after all, is the point of this point of the new tax law.
In the second part of this series we will discuss the “Repeal of Deduction for Alimony Payments” in that “Tax Cuts and Jobs Act” and how this will be applied and how it will help the Federal Government collect more income tax.