Maintenance Under the Tax Cuts and Jobs Act — Part 1

{4:00 minutes to read} On December 22, 2017, the “Tax Cuts and Jobs Act” (TCJA) was signed into law. One of the most significant changes found in the TCJA for couples seeking a legal separation or divorce is the elimination of the “maintenance* deduction.”

Prior to the TCJA, maintenance was a tax deduction to the person paying it (the payor) and taxable income to the spouse receiving it (the payee). Since maintenance is always paid by the spouse in a higher tax bracket, this tax deduction was a way for a couple to shift income so the higher wage earner could pay more to the lower wage earner.

The Issue:

In January of 2016, New York signed a law into place that created “Guidelines” for the amount and duration of maintenance. These guidelines were developed under the old tax law where maintenance was a deduction to the person paying it and income to the person receiving it. Therefore, the financial impact for each spouse today is much different than it would be under the old tax laws.

For Example:

Harry makes $150,000 per year and is in a 30% tax bracket while Wanda is not employed outside the home and has no income. The amount they owe in taxes on $150,000 is $45,000. (30% of $150,000). Therefore, the family has $105,000 in “after-tax” income.

If Harry and Wanda were to divorce and Harry paid Wanda $50,000 in maintenance, under the prior tax law his taxable income would be $100,000. His tax on that amount is $30,000 and he has $70,000 of “after-tax” income per year.

On the other hand, if Wanda was in the 20% tax bracket, she would have $40,000 of “after-tax” income ($50,000 less $10,000 tax). Therefore the family would have $110,000 in “after-tax” income.  

Since Harry is no longer able to deduct the $50,000 from his income, his tax is now $45,000 (30% of $150,000). Therefore, after paying Wanda $50,000 and $45,000 in income tax, he has $55,000 of “after-tax” income. The change in the tax law has cost him $15,000.

Wanda, on the other hand, would have paid $10,000 in tax on her maintenance under the old tax law (20% of $50,000) and would have $40,000 of “after-tax” income. Under the new law, since she does not pay any tax on her maintenance, she would have $50,000 of “after-tax” income, or $10,000 more income.

However, the “family” income is now $105,000 rather than $110,000 and the IRS will receive $5,000 of additional tax. In fact, by most accounts the U.S. Treasury will receive an additional $10,000,000,000 (that’s billion) dollars by this change in the tax law.

Obviously, Wanda likes the new amount and, at first glance, benefits under the new tax law. However, Harry is going to be very unhappy paying support with “after-tax” dollars and is unlikely to agree to do so. In addition, the family has lost $5,000 in spending power at a time when most families need all the income they can have to make ends meet in separate households.

So, what can they do to achieve a better result for both of them? In my next article, I will outline several ways they might do this.

*While New York now calls alimony “maintenance,” the IRS continues to use the term “alimony.”