Any American with a pulse knows that 2017 was to be the first overhaul of U.S. Tax Law since 1986. Until this week, what was circulating through Washington was an 18 page executive summary. That changed yesterday when the House Republican Tax Policy Committee circulated a draft bill that specified exactly what changes were being proposed.
The draft bill summary merits some review because parts of it will affect most of us. But the divorce bar was shocked to see that among those tax “loopholes” on the chopping block is the alimony deduction.
Going back to the 16th Constitutional Amendment, which allowed a federal income tax, there has almost always been a deduction to the person paying alimony on the basis that the deduction would be a corresponding income item for the person receiving the payment. This rule has been uniform. But, it may be changing now. Yesterday’s draft proposal has a Section 1309. It repeals the alimony deduction for agreements and orders entered after December 31, 2017. What could this mean for you? You can still make your alimony deal now, but if this law passes and goes into effect, alimony after 2017 that comes out of new agreements or new court orders will not have any transferred tax effect.
Why would Congress care? After all, payor’s deduction from income becomes payee’s reported income. Revenue neutral right? Well, not quite. Most payors are in higher marginal tax brackets, 31%, 35% and 39.6%. A dollar of alimony costs the payor 69 cents, 65 cents or 60.4 cents, depending on the bracket. The payees are usually in 15% or 25% brackets, so the government loses revenue because the payee is reporting the same alimony but paying a lower rate than the payor. The Republicans say this costs the Treasury about $830 million per annum. Eliminate the deduction and reduce the deficit or at least help pay for other tax cuts.
In real world terms suppose I enter an agreement on December 31, 2017 and agree to pay $50,000 a year in alimony for five years. If my tax bracket is 35%, it costs me $32,500. If my ex-spouse is in a 25% bracket, she reports the $50,000 and gets to keep $37,500 after tax. The government effectively subsidizes $5,000 of revenue it would otherwise get but for the present scheme. Under the proposed bill if the agreement is signed on January 1, 2018, I have no deduction and my ex has no income to report. The payee just got a 25% increase in support based upon the same facts.
Further complicating this is the fact that for more than twenty-five years the Pennsylvania support guidelines have “assumed” that spousal support and unallocated orders of spousal and child support are fully deductible. The tax assumptions are said to be “cooked into” the guideline numbers themselves. If the current bill passes, there is some uncooking that needs to be done because the assumptions have now been undone.
Why devote all of this energy to what is just a first draft bill? After all, this will have to go through many iterations and may change or be eliminated. True enough with one exception. 2018 is an election year. Republicans in 2016 told the world that this Congress was going to reform health care and revise the tax laws. So far, nothing has been accomplished and most legislators will not want to be campaigning this time next year on a “look what wasn’t accomplished” platform. So, this bill has a good chance of moving very fast and a decade’s long tradition of alimony tax law may recede into the mists of time. Stay tuned.