New Tax Law Provides Incentive to Settle High-Income Divorce Cases by the End of 2018

Under the “Tax Cuts and Jobs Act”, starting January 1, 2019, the higher-income divorcing spouse will no longer have an alimony deduction for spousal support he or she might be ordered to pay an ex-spouse and must pay federal taxes on it, while the receiving spouse will not have to pay any taxes on it. This is a significant change to our law and will hurt those who earn vastly different incomes and are taxed at different rates. Divorces finalized by the end of 2018, (December 31, 2018) will still utilize the old tax law and, as such, allow the higher-earning spouse to deduct the alimony paid to ex-spouses from his or her income, while the spouse receiving spousal support would be still be taxed at his or her lower tax rate. The tax break, which will now only be available for divorces finalized by the end of 2018, allows people paying alimony to deduct those payments from their income before calculating what they owe in taxes.

The big concern is for higher earning spouses because they will now lose the alimony deduction for spousal support if their divorce is not finalized by the end of 2018. Higher earning spouses who cannot finalize their divorces by December 31, 2018, may want to now argue for lower alimony payments. Clients should, however, be cautioned to determine whether arguing to pay less in alimony will cost more in legal fees than they would pay in federal taxes on the alimony if they settled; is this new issue cost-effective to litigate? High-end divorce clients may now need to devise complicated workarounds if their divorces cannot be completed by year’s end. These workarounds may include shifting the balance between cash and property changing hands in a settlement and funneling “support payments” through tax-exempt retirement accounts. This may also mean less money for the spouse receiving post-divorce support. Wealthy divorcing spouses, who cannot make the end of year deadline, may choose to forgo alimony payments and accept more lucrative real estate, larger shares in tax-deferred retirement accounts or a combination thereof that minimizes tax advantages. A Qualified Domestic Relations Order (QDRO) may be established to effectuate future payments to a lower-earning spouse from the higher earning spouse’s retirement account, which could still then be taxed at the lower earner’s tax rate. Financial advisors who specialize in divorce can assist with the structuring of these settlement options.

In addition, “unallocated support payments” including both spousal support and child support but with no allocation between the two kinds of support will no longer be tax deductible for any new or modified divorce agreements starting in 2019.

It is accordingly now more important than ever for spouses considering divorce to consult with their attorneys, accountants, and financial planners sooner rather than later; divorces involving high-income earners should be resolved as quickly as possible and, in the appropriate case, should be mediated rather than litigated to assist the parties to resolve their differences sooner than they would be able to in the context of litigation. Please contact us to set up a free phone consultation and/or in person initial consultation to discuss these issues; we would welcome the opportunity to help you and yours address and, hopefully, resolve these issues without undue costs and acrimony.