UPDATE (4/27/18): The proposed law in the General Assembly mentioned below did not pass in 2018. As a result, as far as I know, there is currently no plan to review or revise the child support guidelines in Virginia as a result of the potential impact of the tax law on spousal support. The General Assembly will likely consider this again in 2019.
Introduction
"In this world nothing can be said to be certain, except death and taxes." Benjamin Franklin's wise words, written many years ago, seem to resonate even stronger these days. Taxes impact a shockingly large percentage of what we do in life - everything from our charitable donations to housing decisions to career and business choices. It should be no surprise, then, that taxes play an outsized role in divorce cases as well. It also should not be too surprising that when the Republican tax bill was passed into law late last year, the far-reaching bill included provisions ready to wreak havoc on divorce law.
The most obvious way that the tax law impacts divorce is in the field of spousal support (alimony). Prior to the new tax law, spousal support was considered taxable income to the payee and tax deductible to the payor, unless the parties agreed otherwise. The new tax law changes this - spousal support will now become like child support, neither taxable to the payee nor deductible to the payor. This change, however, is not as simple as it seems. It will make divorce cases harder to settle, child support and property decisions more complicated, and will squeeze the financial resources of already resource-squeezed divorcing families.
However, there are two twists. While most of the tax law went into effect beginning January 1, 2018, the change to spousal support does not go into effect until January 1, 2019. This means we know this change is coming in advance. The second, even more important twist, is that pre-determined spousal support is grandfathered. This means all spousal support paid as a result of an order entered prior to January 1, 2019 will still be deductible to the payor and taxable to the payee after January 1, 2019.
In family law, we routinely try to discourage couples from moving too fast. Divorce is a major life decision, and not one to be taken lightly. But, we family lawyers would be doing a disservice to our potential clients if we did not make this abundantly clear - if you are contemplating a divorce, 2018 is the year in which to do it. Beginning in 2019, divorces will be harder, more confusing, more financially draining, and less likely to settle. If you're thinking of getting divorced - the time has probably come to make a decision.
"Grandfather" Clause
Rules and regulations about the new tax law are still being written, so read this with the caveat and understanding that some of this is still subject to change, but here's the basics. All spousal support orders entered on or after January 1, 2019 (with the exception of modifications mentioned below) will be subject to the new rules - the support will not be taxable to the payee nor deductible to the payor. These orders include not only new divorces, but modifications of existing spousal support orders (again with the exception of what is noted below).
So, all spousal support orders entered prior to January 1, 2019 will be subject to the old rules for so long as that order is in effect - meaning support resulting from those orders will still be taxable to the payee and deductible to the payor until the support is modified or ends.
All spousal support orders resulting from an agreement entered prior to January 1, 2019 will also be subject to the old rules for so long as that order is in effect - meaning support resulting from those orders will still be taxable to the payee and deductible to the payor until the support is modified or ends.
Finally, all modifications of spousal support agreements or orders that were entered prior to January 1, 2019 will be subject to the old ruled unless the modification order or agreement states otherwise.
So, the new rules will apply to all new spousal support orders and agreements entered after January 1, 2019 and all modifications to old agreements or orders that specifically state the new rules apply.
Beginning January 1, 2019, the old rules will still apply to all spousal support orders and agreements that were entered before and have not been modified since January 1, 2019, and to all modifications since January 1, 2019 to old spousal support agreements and orders that did not specify that the new rules apply.
Impact on Settlement
The old tax treatment of spousal support is a friend to many family law attorneys trying to settle cases. This is because when parties cannot agree on how a piece of property is to be divided, it is quite common to turn to spousal support as the solution. Instead of financially dividing the property directly, the higher earning spouse agrees to pay a certain amount of spousal support to the lower earning spouse in exchange for the lower earning spouse waiving his or her right to the property. The higher earning spouse will frequently end up paying on net less than he or she would have for a straight property division while the lower earning spouse will frequently end up receiving on net more than he or she would have for a straight property division because the higher earning spouse's additional tax savings from the spousal support will be greater than the lower earning spouse's additional tax liability due to the varied tax brackets.
Moreover, the old tax laws made spousal support much easier to settle on its own. Higher support amounts were always more palatable to a payor when he or she knew that they would be deducting that money from their taxes. A payee may now not have to set aside funds for estimated taxes, but the lower spousal support amounts likely to result will often mean the payee will have to choose between accepting less money than he or she needs, or fighting it out in court.
Impact on Child Support
At first blush, a change to the tax treatment of spousal support does not seem like it should impact child support at all. However, if you know how child support is determined, you quickly realize this isn't the case. As you probably already know, in most cases child support is determined by a set of state-sanctioned guidelines. One of the inputs for the guidelines is the income of each parent. However, of relevance to us, the guidelines also consider spousal support - spousal support being deducted from the guidelines income of the payor, and added to the guidelines income of the payee.
There is a problem with this going forward, however. The child support guidelines are based on gross income. That is, income before taxes. In a world where spousal support is deductible to the payor and taxable to the payee, the guidelines' treatment of spousal support makes perfect sense - spousal support in that world really is a change to the parties' gross income, so it should be treated accordingly.
In the new world, spousal support is instead a change to the parties' net income. If it continues to be treated the same way by the child support guidelines, this will be unfair to the spousal support payor because the gross income impact of his or her spousal support payment is now a larger decrease than the support payment itself, but only the net income impact would be getting deducted from his or her income (and similarly, the payee gets a bit of a windfall, since the gross income impact of his or her spousal support payment is now a larger increase than the amount of support itself, but only the net amount is being added to their income). If spousal support is removed from the child support guidelines altogether, this would be even more of a windfall to payees, unless the formula used in the guidelines were changed, which would then unfairly impact the families where there is no spousal support involved.
The most logical way to handle this, then, would seem to be for spousal support to continue to be handled the same way, except have it increased by a certain percentage when plugged into the guidelines. Setting that percentage would be challenging, however. The General Assembly seems to recognize this, and is currently considering HB 1331 which, if passed, will require the state's Child Support Guidelines Review Panel to conduct a review of the guidelines outside their usual every four year window. The purpose of the review would be to propose any changes necessary to bring the guidelines into compliance with federal law, which mandates that the guidelines determine child support "appropriately." However, the report on this review would not be due until November 1st, and any resulting legislation would likely not come into force until well into 2019.
What this all means is that, unfortunately, for some time going forward, more child support cases are going to likely have to get into deviations from the guidelines (deviations based on "tax consequences" are allowed by the Code), which, like in the previous section, likely means more costly litigation, and less settling.
Impact on Total Finances
Imagine a spouse who earns enough money to be in the 28% tax bracket and one who is in the 10% bracket. The higher earning spouse pays $24,000 a year to the lower earning spouse in spousal support. Under the old law, the higher earning spouse would save $6,720 in taxes because of spousal support, while the lower earning spouse would owe $2,400 in taxes because of spousal support. This means that there was effectively an extra $4,320 available to the family unit because of tax law.
Under the new tax law, that $4,320 is gone. The higher earner gets no savings from taxes. In order to effectively pay the same amount, the spousal support would have to be reduced to $17,280 a year. However, in order for the lower earner to effectively receive the same amount, spousal support would have to be $21,600 a year. I've already discussed how this disparity is going to make cases harder to settle, but even after they do settle or resolve in court you've still got a problem - no matter what, under the new law, one or both former spouses will end up with less money than they would have under the old law. When considering that divorcing families are already frequently in financial distress, this backdoor tax increase will create a real hardship for many divorcing families.
Why 2018 May be the Year to Get Divorced
All of this comes together to reach my ultimate point. We know this change in law is coming, but there is a way to avoid the difficulties settling, the complicated child support calculations, and the loss of combined financial resources - get divorced in 2018. Because of the grandfathering of the law, if you get divorced this year, you can still take advantage of the old law's tax benefits, before they disappear.
As I state in the intro, I never want to rush anyone into divorce. But the reality is that if your goal is to keep as much money as possible within the family, avoid unnecessary litigation costs, and keep things simple - you're far better off divorcing in 2018 than in 2019.
Conclusion
The new tax law is set to make a major impact on divorces across the country. No change is likely to have a greater impact on family law than the change in the tax treatment of spousal support. Among other potential impacts, it will make settling cases harder, child support more complicated, and reduce the total amount of money available to divorcing family units. Overall, it makes 2018 a financially superior year to get divorced than 2019 and beyond. If you are thinking about a divorce, and the tax law has you ready to make your decision, feel free to read our initial consult policy, then call (703)281-0134 or shoot me an e-mail at SLeven@thebaldwinlawfirm.com to set up an initial consultation. Our initial consultations are free for up to half an hour.
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