Why some wealthy Americans may be thinking about getting a divorce before the end of this year - thanks to Donald Trump
In December 2017 Donald Trump signed into law sweeping changes to the US tax code. The new law eliminates a 76 year old tax deduction for those who are paying alimony (or spousal maintenance, as it is called on this side of the pond). Currently, people paying alimony can deduct those payments, no matter how large, from their income, before paying tax. The new law will take effect on 1 January 2019, and it has far-reaching implications for US individuals who are divorcing – or even thinking about getting divorced. Why?
- Currently, Americans who are paying alimony have been able to take a tax deduction on their annual tax returns. Those receiving alimony are required to pay tax on it. Unlike UK citizens, Americans are required to file tax returns on an annual basis, declaring their worldwide income to the US government regardless of where they live. That means that this change will impact all Americans, including those living in the UK.
- The alimony deduction has been particularly beneficial for wealthy individuals, who can often significantly reduce their tax bill by making alimony payments to a former spouse. Although the recipient has to pay tax on the alimony they receive, they are normally less well off, and pay tax at a much lower rate than the paying spouse. Child maintenance, unlike alimony, does not qualify for a tax deduction, but so called “unallocated support” that is intended to benefit a former spouse and a child, does. This will also change in 2019.
- Historically, the potential for individuals to make tax savings as a consequence of their divorce has acted as an incentive for spouses to pay alimony to a former spouse, particularly for wealthy individuals who pay the top rate of federal income tax, which is 37%. Some US family lawyers argue that this has made it easier for divorcing couples to reach agreement, because even the very wealthy have an incentive to settle, rather than litigate.
- Some US lawyers and financial advisors are telling clients who may be contemplating a divorce that if they want to take advantage of the alimony deduction, they should act now. This applies equally to wealthy individuals and those who are likely to receive alimony, because if their wealthier spouse no longer receives a tax break for paying alimony, they may be less motivated to settle. Those receiving alimony are also more likely to feel the impact of these changes if it means that their income is reduced. The reality is, however, that not all divorces can be resolved amicably, and those that go through the courts (whether in the US or in England) are unlikely to be resolved by the end of the year.
- There could also be repercussions for those who signed pre-nuptial agreements before the new legislation was introduced. Although the agreements may provide for alimony payments to be tax deductible, it is unclear whether these provisions will be upheld when the new law takes effect. As a consequence, some couples may wish to re-visit their pre-nuptial agreements. Even if this prompts an uncomfortable conversation, it may be worthwhile.
Will the new legislation impact those who are already paying and receiving alimony? Most experts say that individuals who are already divorced have nothing to worry about. But any Americans who are considering a divorce should think carefully about their next steps and consult their financial advisors about what these tax changes mean for them.
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