The latest Republican tax proposal would be the best thing that ever happened to America’s divorce litigators. From “The Tax Bill’s Fine Print: Tuition, Medical Expenses and Alimony” (nytimes):
Divorce would become a bit more burdensome for the ex-spouse who paid alimony because it would no longer be a deductible expense. But the party receiving the payments would no longer need to pay tax on the income received.
Alimony profits may be fixed by custom or statute, but in any case are always a function of the lawsuit loser’s pre-tax income. Awards of 1/3 to 1/2 of the target’s income are common. Currently, for example, a plaintiff (“dependent spouse”) who wants to have sex with new friends might obtain 50 percent of the former sex partner’s (“breadwinner spouse”) income as alimony. This ends up working out to be a loss to the Treasury under our progressive tax rate structure because there are two $100,000 per year taxpayers instead of one $200,000 per year taxpayer. The loss will typically be larger because, while the payor is almost surely going to claim the deduction, the successful plaintiff is statistically unlikely to report the $100,000 in income at all (see “Litigation, Alimony, and Child Support in the U.S. Economy” for a summary of a 2014 U.S. Treasury Inspector General study).
If plaintiffs are rational economic actors there will be a huge rush to the divorce courts as soon as this law goes into effect. Obtaining 50 percent of the defendant’s pre-tax income but on a tax-free child support-style basis would mean, in the high-tax states that tend to favor alimony, getting nearly all of the defendant’s practical income (e.g., the defendant might pay 40 percent of his or her income in taxes and 50 percent to the plaintiff and have roughly 10 percent left over to spend; top marginal tax rates in the U.S. range from about 43 percent to 52 percent). If a plaintiff can lock in an alimony award under a state’s old system, but pay no tax on the alimony under the federal government’s new system, that would be a dream outcome.
Another potential motivator for divorce and never-married custody/child support lawsuits is that the IRS rule has been that the winner parent also gets any tax deductions or credits associated with children. So the loser parent pays all child-related expenses with after-tax income while the winner parent gets the tax breaks that are promoted as assisting parents who incur child-related costs. For a successful child support plaintiff, the result is a 0-percent tax bracket up to moderate levels of income (“moderate income” is typical because cutting back working hours to part-time is a common response to winning a divorce or custody lawsuit). It looks like this system remains in place under the proposed tax system, which includes child-related tax credits that would be harvested by the winner parent.
[Separately, the way that the Times phrases the change is interesting. Having potentially nearly 100 percent of one’s income taken away by the government and a plaintiff is “a bit more burdensome” than the current system where perhaps 75 percent is taken. And perhaps whatever burden is suffered by the defendant is not worth worrying about because there will be a corresponding benefit for plaintiffs: “But the party receiving the payments would no longer need to pay tax on the income received.”]
Readers: Is there any chance of this bill passing? Why is Congress only now getting around to this? If they had the votes to monkey with the tax code why couldn’t they have done it back in February, for example?