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As this is written, the House and Senate this week are scheduled to vote upon a conference report of both houses of Congress which will “reform” tax law in a major way for the first time since the Reagan administration.  In order to secure passage, Congress needed to find some revenue enhancements to offset the tax reductions allocated to corporate and estate tax payers.

As we predicted in November, alimony as a tax deduction to the payor and an element of income to the payee, appears to be one of the revenue enhancers Congress decided to keep in the final bill, with one twist.  The House version ended alimony as a deduction for any decree or agreement formed after December 31, 2017.  The Senate version of the reform bill did not change the rules relating to alimony.  Thus, we anxiously awaited what would come out of the conference report published on Friday, December 15, 2017.  The 1000 page report can be found at http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT-466.pdf . Make certain you have your tax code with you when you start to read as the conference report is only a description of the amendments without the Code.

We did this.  In a nutshell, the Conference Committee adopted the House version but delayed implementation for one year.  Therefore, if you are negotiating or litigating a divorce case and you conclude your matter by agreement or decree before December 31, 2018 (a year from now), the old alimony rules apply.  But, beginning with tax year 2019, any new decree or agreement providing for alimony will be tax free to the recipient and nondeductible by the payor.  As Steve Hurvitz, current head of the Pennsylvania Bar Association Family Law Section observed when he read the bill; “There will be a lot of deals made in 2018.”

The effect of this and other changes in the Tax Code “on the ground” in Courthouses across the state is going to be seismic.  The current support guidelines have deductibility “baked into” the formula.  So, Congress is ripping up those rules.  Other adjustments to gross income that are used to calculate net income for purposes of support are similarly affected.  Mortgage interest is capped at $750,000; state and local tax deductions (including real estate taxes) are also capped at $10,000 ($5,000 if filing separate).  Personal exemptions disappear.  Home equity loans are no longer deductible.  All miscellaneous deductions (e.g., accounting tax prep fees) are eliminated.

The standard deduction is now:

Individuals:  $24,000 if married joint

Heads of Household:  $18,000

Single and Married Separate filers:  $12,000

Indexing rates and other tax items (dependency exemption ) for inflation has been repealed.  The child tax credit is elevated to $2,000 per qualifying child and would not phase out until $200,000 for non-joint filers and $400,000 for joint filers.

One thing would seem to be clear.  If you have a visit to Domestic Relations or a court proceeding in support scheduled for early next year, none of the algorithms in the support calculating software are going to provide a reliable result.  Perhaps the largest adjustment relates to income paid through a qualified partnership, “S” corporation or sole proprietorship.  Twenty (20%) of that qualified income is deductible.  The practical effect of what is or is not deductible is going to be the subject of IRS created regulations.

We have still not seen a copy of the Senate bill although PBS Newshour reports that the final version adopted by the Senate was not circulated in the Senate until late Friday evening and about 5 hours before the vote.  However, it appears that the Senate bill does not change existing alimony rules.  As noted on Listserve last month, the House version does abandon alimony as a deduction effective January 1, 2018.  If you are negotiating an alimony provision you need to be carefully following this issue on behalf of clients.  The one thing which all reports appear to confirm is that tax reform is a freight train that will not be stopped.  The House is scheduled to go out of session on December 14.  The Senate one day later.  The House needs to pass a bill in that time and the Senate and House need to decide on a “common” bill for joint passage and transmission to the President.  The House is circulating a bill that would forestall next week’s government shutdown until December 22, 2017, which would signal that they plan to extend their session.  But, suffice to say, the next ten days should provide plenty of excitement.

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.

On October 5th of this year, the Superior Court disposed of an alimony modification request that was decided by the trial court in October, 2014.  The facts and the ruling present a tale of how divorce practitioners need to pay heed to language when modifying an order of alimony.

Egan v. Egan, 2015 Pa. Super. 2013 was decided in Montgomery County, Pennsylvania but began as a divorce in Montgomery County, Maryland.  In 2002, the Maryland Court issued a divorce decree with an alimony order providing for one year of alimony at $4,000 per month and then alimony of $3,000 per month “thereafter.”   In 2004 the former husband filed to register the alimony award in Montgomery County, Pennsylvania and in April 2005, the parties formed a stipulation that transferred both the alimony and child support to Pennsylvania.  The Pennsylvania order made several modifications to alimony, child support and arrearages.  The Pennsylvania Order contained a provision that should father succeed in reducing his child support, his alimony obligation would have a corresponding increase.  We have seen these kinds of arrangements in agreements for many years, but this is the first time we have seen this discussed in an appellate case.  If Father petitioned to decrease child support, the agreed upon increase in alimony was also to render the revised alimony number, non-modifiable.  This agreement was made an order of court in April, 2005 in Pennsylvania.

In February, 2013 Husband/Father filed in Pennsylvania to modify the alimony.  Wife/Mother countered that the alimony was non-modifiable because what was submitted in 2005 was a stipulation or “agreement”.  In a ruling made without a hearing, the trial court ruled as a matter of law that the 2005 document was an agreement under Section 3105 of the Divorce Code and therefor was not subject to modification.  It also held a hearing on Wife’s counterclaim and held Husband in contempt for failure to comply with the 2005 stipulation.  Husband or rather ex-husband appealed.

Because the Maryland divorce decree mandated payment of indefinite alimony, it appears that the Pennsylvania court viewed the alimony award as modifiable as registered here in 2004.  But the “agreement” to modify the alimony and child support provisions of the Maryland decree after registration in Pennsylvania was “agreed”.  The Superior Court ruling is a determination that in resolving the modification of alimony by “agreement”, the parties took an order that otherwise was subject to modification under Section 3701(e) and converted it to an agreement under Section 3105(c).

Section 3105 (c) states that an agreement regarding disposition of existing alimony shall not be subject to modification absent “a specific provision to the contrary.”  In this case, husband argued that Section 3105 governed only those cases where there was a comprehensive agreement.  The Superior Court rejected the argument that agreements under Section 3105 need to be comprehensive, holding instead that if he wanted his 2015 modification to continue to permit further modification, that language needed to be written into the modification instrument.  His argument that alimony was modifiable because he never did seek a modification in child support was rejected for similar reasons.  By reaching the agreement embodied in the 2005 stipulation, husband took an otherwise modifiable alimony order and transformed it into a non-modifiable agreement.

The opinion discussed at length the policy reasons behind the difference in modifiability between Court ordered and agreed alimony.  In a word, the view expressed is that parties to an agreement understand that non-modifiable alimony under Section 3105 is a fundamentally different animal than agreed alimony under Section 3105, and that the parties have to understand that when they negotiate agreements.

The net of the ruling is that a party seeking to modify judicially ordered alimony needs to understand that unless the right to modify again is clearly enunciated, the right is lost where an agreement is reached.  This might be said to have a chilling effect upon such agreements, but the Superior Court found the statutes in controversy to be unambiguous.  It also found the argument that the unmodifiable alimony obligation was onerous (62% of payor’s net monthly income) to be unworthy of consideration.

To the practitioner, the lesson is to draft alimony modifications with great care. To the layperson, the lesson is, do not try to modify your own alimony orders without someone with experience looking at your modification documents.

 

 

Yes, it is tax time once again and the struggles over who got Christmas morning in December now give way to “who gets the deductions and credits” associated with the minor child.  Here is the primer which is offered subject to the advice of income tax preparers.

In ancient times, which is to say, before 1984, the Internal Revenue Service used a support test to decide who got the deduction for a child.  But that is not the archaic view and we today assign the deduction to the parent who has custody more than half the time, no matter who pays what support.  If time is equally allocated the deduction goes to the parent with the higher adjusted gross income.  That may not seem fair but it is the law.  Many parents like to fight over whether mom or dad really had more than 50% but on that subject, chances are the IRS is going to say: “Send us the custody order; we don’t care what really happened.”

So, you couldn’t take living with Mr. or Mrs. Always Right anymore and you packed up the truck and move back with your parents on July 1, 2014.  What is your filing status?  The answer appears to be found in the Tax Code at Section 7703(b). Spouses “legally separated” under a decree of “separated maintenance” are not considered married for tax purposes.  Wofford, 515-2d T.M. Divorce and Separation, p A-70.  Unfortunately, Pennsylvania does not really define “legal separation” in the sense that it issues some decree of separation.  And it appears that a garden variety order of spousal support or alimony pendente lite or a separation agreement does not meet the test.

There is something called the abandoned spouse test.  If a taxpayer files a separate return and maintains a separate home where a child resides for more than half the year such that the child can be claimed as a dependent and that taxpayer provides more than half of the cost of maintaining the household occupied by that child, that taxpayer can claim to be unmarried. Bear in mind that the spouse cannot have been a resident of that taxpayer’s independent household during the last six months of the year. Costs of maintaining the household include rent, mortgage, taxes, utilities, insurance, maintenance and repairs and food consumed in the household.  These abandoned spouses qualify as heads of household, even though they may have been the spouse who departed.

There is a tax credit for care expenses required in order for the taxpayer to work.  The Dependent Care credit applies where the expense is to care for a child not older than 12 or a spouse or dependent who is physically or mentally unable to care for himself.  In order to claim the credit the person who needs the care must live principally with the taxpayer claiming the credit.  The credit starts out at 35% of the cost of the care but is reduced by 1% for each dollar of adjusted gross income over $15,000 per annum.  The phase out does not go below 20%.  Meanwhile the maximum credit is $3,000 per individual or $6,000 if filing jointly.

In addition to Dependent Care credits there is the Child Tax Credit.  This ties to who has the dependency exemption.  Bear in mind, the law presumes it goes to the parent having primary custody but the exemption can be assigned to the parent having less than 51% custody.  The credit is $1,000 per qualifying child.  The child must be 16 or younger and must have his/her principal abode with the person claiming the credit.  It phases out at $110,000 for joint filer, $75,000 for single and $55,000 for those filing married/separate.

The general rule is that personal expenses are almost never deductible by taxpayers on Schedule “A” (Itemized Deductions) of their personal returns.  But all rules have exceptions and almost everyone is familiar with the deductions available for medical and dental expenses.  These are great deductions but with this hitch.  You only get to deduct the amount that exceeds 7.5% of Adjusted Gross Income.  Thus, it takes some pretty catastrophic medical expenses to get past the threshold.

But there are two lesser known deductions that merit some attention.  Under Section 212(1) of the Internal Revenue Code, a taxpayer may deduct expenses directly attributable to the production or collection of income that is taxable.  Spousal support and alimony is taxable income and both the Tax Court and the Internal Revenue Service agree that counsel fees attributable to the determination and collection of spousal support and alimony are proper deductions under Section 212.  This includes proceedings to collect arrearages (overdue amounts) and to increase alimony payments.  The deductions apply only to the payee.  The payor does not qualify for a similar deduction in defending these claims.

The fees must be reasonable for the goal sought.  Thus a $10,000 deduction to secure a $9,000 increase may be subject to challenge.  The deductions for legal fees are also limited to those greater than 2% of adjusted gross income.  Thus if an otherwise unemployed spouse incurred $10,000 in fees to secure an award of $3,000 a month in alimony, her adjusted gross income of $36,000 per year means that the first $720 (2%) of counsel fees are not deductible.  The deduction is taken on Schedule “A” under “Job Expenses and Certain Miscellaneous Deductions” (lines 21-27 for 2014).

The second and more nebulous area where deductions may be taken is for “Tax Advice.”  Section 212 (2) of the Internal Revenue Code allows deductions for “the management, conservation or maintenance of property held for the production of income.”  This is a far trickier deduction as there are no Treasury Department regulations directly addressing it.  The regulations under Section 212(1) inform us that investment management fees and custodian fees associated with investments are deductible.  The same costs for a personal residence are not. Expenses of estate litigation are afforded deductibility even though not directly related to production of income.  Expenses incurred in asserting rights to property are non-deductible.  But if the property produces income and the claim is related to collection of a portion of it, that “income” portion is deductible.  Expenses associated with preparing tax returns are deductible but again the deduction is for expenses beyond 2% of Adjusted Gross Income.  The general view (not found in the regulations) is that “tax advice” secured for purposes of managing one’s investments is deductible and many divorce practitioners sometimes freely “allocate” a substantial portion of their invoice to “tax advice” to help a client out.  But, this is a slippery slope for both the adviser and the tax payer because unlike the alimony deduction, there is no real means to measure what is reasonable and what is not and to a large degree, the assets being allocated in the divorce are not income producing.

Not the best use...
Not the best use...

A very interesting opinion recently came down from the Pennsylvania Superior Court awarding attorney’s fees in a divorce case. This case is a non-precedential opinion, meaning it cannot be cited as establishing law on the issue, but it is emblematic of the risk one runs if you do not follow the rules.

The parties, two attorneys, in fact, had resolved their divorce by way of a Marital Settlement Agreement in March 2011, about two years after the wife filed for divorce. They also had a prenuptial agreement, so the distribution of their estate was addressed in a comprehensive way and nothing was preventing them from getting divorced.

After the deal was done, however, the husband came back and raised an issue about the return of jewelry he gave wife and about the payment of a ten-percent referral fee for a case he sent to his ex-wife’s firm.

Another two years pass.  In March 2013 wife files an Affidavit of Consent under Section 3301(d) of the Divorce Code. That form of affidavit is used when two years have passed since separation and, unlike Section 3301(c), wife was the only one who needed to file it to establish the no-fault grounds for divorce. Once the divorce decree is entered, the parties are prevented from raising any other economic claims. In other words, if husband wanted the referral fee and jewelry, then he needed to have them dealt by raising the issues with the court.

Husband filed a Counter-Affidavit in conformity with the rules. This document is used whenever a party wishes to raise an economic claim for resolution by the court and this was the first step husband needed to take to address the referral fee and jewelry issues he first raised two years prior.

When filing his counter-affidavit, he checked off the box indicating he wished to raise economic claims. Under that box there is language stating that,

“I understand that in addition to checking (b) above, I must also file all of my economic claims with the prothonotary in writing and serve them on the other party.  If I fail to do so before the date set forth on the Notice of Intention to Request Divorce Decree, the divorce decree may be entered without further delay.”

Husband never filed anything else. When the notice period ended, wife obtained a divorce decree on or about May 2, 2013 and husband lost his chance to address his referral fee and jewelry repossession.

When filing his appeal, Husband took the position that the rule requiring him to file his economic claims with the prothonotary wasn’t really followed in Montgomery County. He argued that the trial court abused its discretion because the court generally does not enforce the rule requiring a party to file their economic claims with the prothonotary. Basically, checking the box was enough, wife knew he had additional economic claims, and they should not have entered the decree (or, rather, declined to strike the decree).

Suffice to say, the Superior Court disagreed and found that husband demonstrated no proof that Montgomery County engages in “[a] routine practice…to allow parties to disregard clear instructions set forth in form documents pursuant to the Rules of Civil Procedure” and that “the trial court flatly denies [husband’s] contention, saying that it ‘is unaware of any unspoken practice not to adhere to the instructions on the form counter-affidavit.”

The Superior Court found the appeal frivolous and agreed with wife’s request for counsel fees from husband. As of this writing, the Superior Court has sent the case back to the trial court to determine how much in counsel fees husband will have to pay wife. He cannot feel very confident that the Court he argued did not, as a practice, follow the rules, is now in the position of deciding how much money he will have to pay his ex-wife.

The major lesson from this opinion is that one should never take the rules for granted and assume they can be ignored; do so at your own risk.

No one is perfect and mistakes do happen, however. No one wants to miss a deadline or misinterpret a rule, but if it happens, do not let your ego or pride push you into making worse decisions.

Opinion available at: Savett v. Rovner, No 1743 EDA 2013

Photo: www.myipadretinawallpaper.com

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Aaron Weems is an attorney and editor of the Pennsylvania Family Law Blog. Aaron is a resident of Fox Rothschild’s Blue Bell, Pennsylvania office and practices throughout the greater Philadelphia region. Aaron can be reached at 610-397-7989; aweems@foxrothschild.com, and on Twitter @AaronWeemsAtty.

One of the difficult aspects of taking a complex case to trial is not the subject matter, necessarily, but the Court’s ability to schedule several consecutive days of trial.  Due to case volume, the court administrators can rarely carve out two or more consecutive days of trial without significant advance notice and, often, direct instruction and assistance from a judge’s chambers. As a result, a judge’s schedule may require you to have a week-long trial spread out over several weeks or months. Not surprisingly, attorneys, witnesses, and even the judges can lose some of the thread of arguments presented in such a disjointed fashion.

An alternative to trial is to take the case to arbitration.  An arbitrator is a third-party hired by the litigants to basically serve in the role of a judge-like finder of fact. The parties sign an arbitration of agreement and usually stipulate to certain ground rules for how they will handle the arbitration. For instance, some parties make the arbitration “binding;” in other words, the arbitrator’s decision becomes the law of the case. 

Another advantage to arbitration is to help limit costs through the arbitrator’s assistance in narrowing issues and avoiding some of the costs of broad discovery. Because the arbitrator is hired by the parties, he or she works on the litigants’ schedule – the arbitrator can set aside a full week for trial at a time that works for all involved and take the time to really hone in on issues without being at the mercy of the court’s availability. Rather than prolonged discovery schedules and waiting for trial, the arbitrator can help move the case to swift conclusion.

Eliminating the pressure of having to fit a two day trial into an afternoon before a judge helps the parties and the courts. Arbitration is one of many forms of “alternative dispute resolution” and by diverting cases off the Court’s docket and into arbitration, the parties are helping to free up the Court to adjudicate other cases.  There is the added advantage of the parties that unlike a court proceeding, the parties can agree to make the record and information disclosed within the mediation confidential.

Finally, utilizing an arbitrator is often like hiring a mediator. Having already reached an agreement to arbitrate and move the case out of court, it may also be possible for the arbitrator to help facilitate other agreements between the parties, be they discovery rules, stipulations of fact, or interim relief.  Agreements often lead to other agreements and once the parties start to work together, it may be possible to resolve the entire case. 

Even where settlement seems impossible, by moving their case into a venue where they will help set the schedule, parties will know that on a definite date they will have had their “day in court” and can expect a decision from a finder-of-fact. The certainty of those two elements, alone, may be its most attractive benefit.

A South Carolina attorney was recently disciplined for failing to have an active email address.

Despite characterizing herself as “retired” and not having a client in thirty years, the South Carolina Disciplinary Board still found that she “poses a substantial threat of serious harm to the public and to the administration of justice” for repeatedly failing to comply with the Court’s rule about having an active email address.

This case got me thinking about my practice, particularly my frustration with the tiny but hardcore group of attorneys who refuse to use email. One more than one occasion, I have had to take extra measures to hand deliver, courier, or Federal Express a document or correspondence to an attorney who does not use email. This has cost my client extra money to accommodate someone who is a rare exception in an industry that has accepted email, faxes, and smartphones (albeit, begrudgingly at times).

In one situation, I hand delivered a copy of a sizable responsive pleading to an attorney’s office. Faxing wasn’t an option and mailing would not work due to the forthcoming weekend. Though I could have served the document on the attorney at our hearing and been in complete conformity with the rules, I wanted to give the attorney the courtesy of having the pleading in advance. Had he used email, he would have had the PDF Friday afternoon to peruse at his convenience over the weekend. No good deed goes unpunished, however, and though his practice methods made service before the end of business on Friday virtually impossible (or, alternatively, cost prohibitive to the client), he nevertheless wrote a letter to tell me my hand delivery on Monday morning, in advance of the hearing, was “offensive.”

I scanned the letter into the system for future reference and dropped it in the recycle bin.

I recognize that some attorneys feel email is the scourge of the 21st century. The incorporation of email into smartphones makes us tethered to work around the clock. But in an industry that is essentially about customer service, it seems irresponsible – and in South Carolina, a breach of professional responsibility – not to have an active email account to communicate with clients, counsel, and the Court. To the best of my knowledge, no attorney in Pennsylvania has been disciplined for not having an email address or, even minimally, a fax machine. I can only speculate that it is a matter of time before a client – having become frustrated by being limited to either in person visits, phone calls, or “snail mail” letters – finds a new attorney or worse, files a disciplinary complaint against them.

 

Leslie Spoltore, a partner in our Wilmington, Delaware office, just posted a blog entry on an unusual alimony argument made on appeal to the Delaware Supreme Court.  The family court evaluated the ex-wife’s expenses when calculating alimony she would pay to her ex-husband and reduced the significant contributions she made to her church down to what it deemed a "reasonable" amount of $100.00.  The Court considered it a voluntary reduction in income. This is not unlike how Pennsylvania’s courts add back, for instance, voluntary contributions to 401(k) accounts when calculating child support and alimony pendete lite. 

On appeal, the ex-wife claimed that the Court’s assessment of alimony based on their consideration of her available income resulted in her inability to appropriately tithe her church and violated her First Amendment freedom of speech.

It is an interesting and creative argument, but did not carry her case and the Supreme Court ruled the family court could consider any factor it deems appropriate and nothing prohibited her from contributing as much as she would like to her church.

Read Leslie’s blog entry and link the decision here.