Now that you understand generally the effects that the new tax law may have on those of you contemplating getting divorced or looking at a possible modification of the orders regarding spousal maintenance, we will now go through a couple of examples to show you specifically how this will affect your pocketbook and “bottom line” in terms of actual dollars and cents and clarify in real terms whether it is beneficial to file now or later after the changes take effect.
Richard and Jane are married, but Richard is considering filing for divorce this year. Richard’s income puts him at a tax rate of 32% and Jane has little or minimal income at this point. Assuming Richard agreed to pay Jane spousal maintenance of $2,000 a month for the next five years to resolve the matter and get divorced in 2018 (prior to January 1, 2019), Richard is looking at a yearly tax savings of $7,680 a year, or $38,400 over the life of the award. Jane will be assessed tax on the $24,000 annual payment, but those taxes at her 12% tax bracket only amount to $2,880 a year. As the standard deduction for single filers is increasing to $12,000 a year, Jane will only pay on one-half of that amount or $1,440. Jane will net $1,880 a month, or 94%, of the entire spousal maintenance payment.
Under this scenario, Richard saves $7,680 a year in taxes ($640 a month) which defrays almost a third of the $2,000 a month spousal maintenance payment, and is paying $16,320 in actual dollars once adjusted for tax. Additionally, Jane is able to pocket the vast majority of the actual payment, $1,880 net a month, maximizing her income to help her transition back into the workforce.
Same facts, except instead of reaching an agreement, Richard and Jane go to trial on February 29, 2019 (after the effective date of January 1, 2019) and the Court subsequently awards Jane spousal maintenance of $2,000 a month for 5 years.
Now, unable to claim his spousal maintenance payment as a tax deduction, Richard is taxed on the whole $24,000 a year at 32%, therefore he is paying a total of $31,680 ($24,000 spousal + $7,680 tax) a year for spousal maintenance after adjusting for taxes - $15,450 MORE – almost twice what he was paying in Example 1 above with the exemption in place. Once the changes in the new tax law are in effect, Jane will not have to claim her spousal maintenance payments as taxable income, therefore she will receive a “tax free” $24,000 a year – which equates to an additional $1,440 annually or stated another way the equivalent of three-quarters of an additional month’s payment. The net effect is, under this scenario, Richard loses an additional $15,450 a year – prorated to $1,287.50 a month - while Jane gains only an additional $1,440 a year or $120 a month in income as a result of the new tax law. The U.S. Treasury is clearly the overall winner.
Example 3: Same facts as Example 2, except Jane has employment which pays her $32,000 annually.
Jane now has total income of $56,000 ($24,000 spousal maintenance + $32,000 earned from working), but only $32,000 of that income is taxable after January 1, 2019. Once the standard deduction is calculated in, Jane only pays $2,400 (at 12%) in taxes on that income instead of $9,680 at a 22% effective tax rate. Therefore, her total net income after taxes is $53,600 a year or $4,466 a month. If that spousal maintenance amount had been calculated in as income, her net income would only have been $3,860 a month or $46,320 annually – an extra tax-free $606 a month benefit to her. On the other hand, Richard still loses an additional $15,450 a year or $1,287.50 a month more now than he did when he was able to deduct his spousal maintenance payments.
As is evident in the examples above, the new tax law will cause dramatically different financial outcomes in cases involving spousal maintenance. Therefore, the predictions by commentators expecting a mad rush of divorces in 2018 seem to be well founded. Additionally we expect that moving forward into 2019 that spousal maintenance will be an even more hotly contested and vigorously litigated issue. The drastic effect on the paying spouse’s income compared to the minimal, or even windfall in some respects, impact to the receiving spouse makes it worthwhile to fight about it and litigate and less likely to settle.
In our next blog, we will discuss some new strategies to consider in negotiations regarding spousal maintenance in light of the coming changes in tax treatment.
Going through a divorce and understanding all of the possible effects on your future income can be difficult at best. Certain provisions and terms dealing with support payments can be complex. Having an experienced attorney to advise and assist you with navigating these issues is essential to protecting you, your pocketbook and your peace of mind.
If you would like to work with one of our experienced divorce attorneys, please call OWENS & PERKINS at(480) 630-2464 to schedule your free 30 minute consultation.