We see many experienced family law specialists make this common DissoMaster* mistake with the health insurance deduction.
Paid By Party
Pre-tax Wage Deduction
So don’t be a DissoMaster dunce!
With the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), the deductibility of alimony or spousal support on federal taxes is set to sunset on December 31, 2018. If you plan to divorce or are in the process of a divorce that will not be completed before the end of 2018, this could cost you a lot of money.
Under the previous law, spousal support (or alimony) is deductible from income for the support payor and taxable to the support recipient. This let parties save money on Uncle Sam’s dime. Typically, the support payor would be taxed at a higher rate than the support recipient because of the disparity of income. By transferring the tax burden from the support payor to the support recipient, the support payor had higher net spendable income and could afford to pay more. This usually ended up in a win-win circumstance for the parties.
Commencing on January 1, 2019, spousal support paid under new orders will not be deductible to the support payor and will not be taxable to the support recipient. This rule will apply to alimony payments required by “divorce or separation instruments” executed after December 31, 2018.
A “divorce or separation instrument” as defined by 26 U.S. Code § 71(b)(2) “means –
(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,
(B) a written separation agreement, or
(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.”
In negotiations husband and wife had agreed that spousaI support would be set at $12,000 a month. Because husband will be in the combined 46.3% tax bracket post-divorce, the after-tax cost to him will be $6,444. However because wife will be in the combined 34.3% bracket she will net $7,884 after tax. When the new law is in force and husband can no longer deduct his payment it would cost him $1440 more to get her the same amount of spendable money. The differential will be even greater if wife goes ahead with her plan to buy a condo next year and thus receive the deductions for mortgage interest and property taxes.
Of course the reality of divorce is that there is rarely enough money to go around and the result of this change is going to be that payors will end up paying more and payees will end up receiving less.
An additional impact of this change that we believe is not well understood is that because in California the software that calculates child support uses after-tax income as the input number used for income available for support, child support numbers will also be reduced.
However, a divorce or separation instruments in place before January 1, 2019, but modified after this date, will remain under the current rules allowing for deductibility. They would only be subject to the TCJA, if the modification expressly provides for the TCJA to apply.
What does this mean for people in the midst of a divorce today? To preserve the possibility of the alimony payment tax deduction, you MUST have a divorce instrument entered by a court before the end of 2018.
Although it is unclear exactly how the IRS will interpret this rule, we believe it is crucial that the divorce instrument be entered before the end of the year to preserve deductibility forever (or at least until the rule is changed again).
A huge concern is that the courts are very much behind in the processing of judgments of divorce or legal separation. Time is of the essence. If a couple does not have a completed judgment to submit prior to middle of November 2018, there is a very strong likelihood that it will not be accepted by the court in time. Thus, the parties would lose the benefit of deductibility because there divorce or separation instrument would not be enterd before 2019.
To help parties maximize what they have to spend for themselves and their kids after divorce, Weber Dispute Resolution is teaming up with Pacific Divorce Management to offer an expedited to process.
Pacific Divorce Management, one of the premier advising firms in San Diego for financial issues in divorce, will work with parties to gather financial data to complete the State mandated Declaration of Disclosure Forms.
Weber Dispute Resolution, a leader in divorce mediation and legal dispute resolution, will prepare the necessary forms to open a divorce case and will work hand in glove with Pacific Divorce Management to prepare the necessary divorce or separation instrument necessary to satisfy the IRS requirements for deductibility.
If it is impossible to conclude the entire divorce prior to 2019, the parties could enter into a partial stipulated Judgment for spousal support that would meet the requirements for the alimony deduction. The couple would then have the following options:
Whether you choose to complete your divorce with us or choose to go another way, we want to help all parties involved in a late 2018 divorce be aware of this change, and take advantage of the tax laws for deductibility of spousal support payments before it goes away forever.
The idea of the “Gavron Warning” came from the case In Re Marriage of Gavron, (1988) 203 Cal.App.3d 705, 250 Cal.Rptr. 148. In this case, the parties separated in 1976 after a 25 year marriage. Subsequently, the court ordered the husband to pay $1,100 per month of alimony. He did so until 1981, when he asked the court to reduce support to $550 and then terminate entirely after one year. This initial request was denied.
However, the husband tried again in 1986. This time the court ordered that support would continue for five months and then terminate. The wife appealed and reversed the trial court’s order. The appellate court held that because the wife was not warned in prior orders to become self-sufficient, she could not be penalized years later because the court did not tell her to make efforts. In essence, as the court argued, the failure to focus her on the expectation to become self-sufficient meant that the court could not cut her support now.
Because of this case, the courts will frequently issue a warning to the supported spouse. Here is an example of a Gavron Warning:
“NOTICE: It is the goal of this state that each party will make reasonable good faith efforts to become self-supporting as provided for in Family Code section 4320. The failure to make reasonable good faith efforts may be one of the factors considered by the court as a basis for modifying or terminating spousal or partner support.”
So, the lesson for support payers is to make sure that the court includes such language in the spousal support order. If it is not, it may be harder to reduce income later if the supported spouse refuses to make good faith efforts to become self-sufficient. When I am representing a support payer, I always ask the judge for a Gavron Warning and I almost always include it in written stipulations. I will also sometimes simply file and serve a written Gavron Warning to the supported party myself at the beginning of the case so that there is no question that the supported party has been warned.
When I am representing a supported spouse, naturally I will not bring the Gavron Warning up. However, if opposing counsel wants it in an order, there is no legal basis to resist it. The moral for the supported spouse is not to count on the alimony as a permanent means of support.
I frequently refer the supported spouse for vocational counseling to assist with re-entering a career. I get as much alimony as I can, but encourage the prudence of planning for self-reliance. After all, no one knows for sure what the future holds. Not only could the support payer try to reduce alimony, it could simply terminate by means of death. Any changed circumstance such as unemployment or disability could force a reduction or termination in support too. The best advice is to use the support as a life preserver to stay afloat in the short run, but take steps immediately to be ready for when the support may no longer be available.
The general rule is that divorce is a personal expense and is not deductible as a business expense. United States v. Gilmore (Gilmore I) (1963) 372 U.S. 39. So the short and easy answer is, “No.”
However, don’t despair. There are still some ways you can get a break from some of those fees.
Even if the fees for your divorce lawyer aren’t deductible, expenses can often be capitalized. Serianni v. Commissioner (11 Cir 1985) 765 F.2d 1051, 1985 CFLR 2892. Talk to your CPA about how this can be done.
Now these aren’t the greatest of deductions because they are below the line. But every little bit helps… right?
If you are interested in deducting some of your legal fees on your taxes, it is important that you have a conversation with your family law attorney early so that (s)he knows to keep track of your fees and what portions may be deductible. Typically, your attorney can give you a letter at the end of the year indicating what portion of your fees was, for example, associated with the collection of alimony. Usually, this so-called “allocation letter” sent by the attorney to the client will suffice as sufficient proof of the deduction to satisfy the IRS. Goldaper v. Commissioner (1977) T.C. Memo. 1977-343, 36 T.C.M. 1381, 1979 AFLTR 1110. However, if your attorney doesn’t know that you will want to claim this deduction, you will put him in the difficult and awkward position of trying to recreate his records. It’s better that he knows from the outset so that (s)he can keep better track.
As with every tax question, it’s a really good idea to talk it over with your CPA. The rules can be complex and there are limitations. However, with a little diligence, you may save some money at tax time.
Kate and William have no prenup! I don’t know how things work in Britain, but according to California law, any assets currently owned by William or later to be inherited would be his separate property and not subject to division in the event of a divorce anyway. Perhaps William simply doesn’t need it. Of course, alimony is a whole other story.
Read the Article at HuffingtonPost