How New Tax Law May Increase A Divorce Settlement

Wednesday, September 5th, 2018

In mediation and other methods of non-litigated settlement processes, the goal is not for the mediator or neutral to remain solely as a referee.  This person may also offer information to the couple about their process.  This may be through providing legal or other information and what-if brainstorming sessions.  The idea is to generate awareness of issues that impact what the couple is doing and how to come to agreement creatively.

One example is with the passage of the 2017 tax reform bill.  The tax changes may make support agreements tougher to reach.  In the past, the government participated in the process by offering one side a tax deduction, and the other side claimed the income.  In the real world, this provided tax savings for the paying spouse.  Income was shifted from a higher tax bracket to a lower one.  That tax savings increased the income options of the lower income spouse while providing a tax break to the higher income person.

The New Tax Rules

That is gone after December 31, 2018.  For those racing for the “exit” before that date, the option of filing a legal separation with the court and entering into a spousal support agreement may preserve the deduction for when the divorce is final in 2019.  But even that option, if successful, will run out on December 31 of 2018.

But there is another part of the code that impacts business owners going through a divorce.  This may be especially true for those with a spouse-partner in the business.

Under revenue code section 199-A a taxpayer may be eligible for a 20% reduction in income based on the profits of the business.  This article is not going to explain the code section or how it may apply specifically.  We do want to bring up the fact that taxes and tax savings are financial assets to be considered in negotiations.

For example, under the new rules, if a spouse owns a business with $100,000 of eligible profit, there may be a $20,000 deduction against all other income on the tax return.  That deduction could result in significant tax savings and a component for the support negotiations.

In the negotiation, if support is $48,000 annually, with the elimination of alimony deductions, that would cost the paying spouse $25,846 in taxes ($73,846 X 35% = $25,846).  That is an expensive payment under the new rules.

With 199-A that calculation may change.  The taxable income may now be reduced by the 199-A deduction.  The idea under the new tax law is to reduce the tax impact on business owners.  The business tax rate drops from the higher personal rate to one that is comparable with the new lower corporate tax rates.  This is done through a deduction.

Under a simple calculation, assuming that the overall effective rate is 21%, the amount needed to pay the same support payment is now $60,760 ($60,760 X 21% = $12,760 in taxes).  This is about a $13,000 tax savings.

The net result in both cases is a payment of $48,000 in support.  With this new 199-A deduction, for some business owners, it is a way to pay less in taxes.  For others, this may be a way to stretch dollars and provide more in support.

Another side of the code section is the impact of salaries paid.  Those are also part of the calculations.  With a divorce, if the spouse had been involved in the business, depending on the post-marital relationship, options around salary and benefits may be another way of shifting income.  This course of action requires that a salary is justified.

In more contentious situations this may not be possible.  But the financial impact of this option may push some to reach a more peaceful and accommodating arrangement.  With divorce being inevitable and support as a required component, making a couple aware of the tools open to them is one role of a mediator and consulting attorney.

These are only illustrations of a concept.  This is not personal tax advice or a projection of a specific tax consequence.  Each person will need to run these complex illustrations for their situation.  But the concept is clear.  Tax issues matter and have a financial impact on divorce.  Take a closer look through One Last Look™ to review issues as they may impact a specific situation.

Armand D’Alo and Robbin D’Alo