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?
“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”
What fraction of divorce defendants are actually in this situation (i.e. the person receiving alimony has 5X more spendable income than the person paying the alimony)?
Neal: What fraction are in this situation under the current tax regime from an alimony lawsuit loss? Very few. That’s why the new law would provide such dramatically improved incentives for plaintiffs.
Under the current law, if there are no children, the plaintiff who wins a 50% alimony judgment and complies with applicable IRS regulations (i.e., actually reports the income) will have, in theory, exactly the same after-tax spending power as the defendant. In practice, the plaintiff won’t have to work while the defendant must spend 10-20 hours per week commuting and 40-50 hours per week working. So the defendant’s spending power will be reduced by commuting costs and the need to pay for time-saving convenience services. Thus the 50% alimony winner should have a somewhat higher practical spending power than the loser.
(For the plaintiff to obtain a larger spending power than the defendant under the current tax code it is typically necessary to obtain a child support order. Some of the better ones that we’ve seen in Massachusetts provide for 80 percent of a defendant’s after-tax income to be transferred to a plaintiff who had gotten “primary parent” status with respect to two children. So in that case there was a 4:1 ratio in spending power (with similar child-related expenses because the loser parent must care for the children about 30 percent of the overnights and therefore needs the same amount of bedroom space as the winner parent). Sometimes the winner parent can get a free house and, though child support is nominally less than 50 percent of the defendant’s after-tax income, the overall spending power is higher (but not the 5:1 ratio that will be enabled more or less automatically by this new tax policy).)
Looks like this is Massachusets/California etc issue. Looks like there is no divorce for the loosing parent there, financially he/she bound to stay married. Maybe will spend more time with their children because time now is well defined and mandatory and not interfered with by late work/commute/late party time. And no personal relationship with former spouse.
Tax break was written for deploarables, big tactical mistakes for coastal voters to put al their eggd in Democrat bucket. I am sure that coastal Democrats are just as happy as divorce plaintiffs!
Anonymous: You’re right about the concept. Once the marital and/or sexual relationship is over, the courts in some states have a philosophy of trying to identify the “dependent spouse” and then order the financial relationship between this person and the “breadwinner spouse” to continue indefinitely.
However, the studies show the opposite of your conjecture regarding time with the children. Following a divorce in a winner-take-all state, it is more typical for the children and the loser parent to drift apart. See http://www.realworlddivorce.com/ChildrenMothersFathers for references to some journal papers. Remember that, due to slavery having been abolished, a court can’t order the loser parent to take care of the children. Courts can (and do) order cash to flow from loser to winner and can enforce those orders with prison time, etc.
#5, My personal experience with divorce is limited by observations not related to my family or realtives and I hope it stays this way. I observed a divorce where mother and child moved to antoher state but under court approved arrangement should bring child back for few weeks or months to be with child’s father, per father’s demand. Reportedly (really I do not know), prior to divorce, the father rarely took care of his child, so it looks like a wecome change. There is no way father can skip on parenting when child lives ONLY with him.
Anonymous: That makes logical sense. We accept the plaintiff mother’s contention that the defendant (merely biological) father had near zero interest in the child (coincidentally, this turns out to be helpful in obtaining custody and therefore cash). This guy who almost never did anything with the kid ( we wouldn’t want to imagine that the mother would lie in court) turned out to be willing to fund a lawyer to defend the custody portion of the lawsuit and seek scheduled periods in which he would be the only person taking care of the child. Now, despite not being paid for his time, he voluntarily babysits a child that, according to the plaintiff, he never cared about…
If this guy is happy to take care of kids that he never took care of before, can you please ask him to come over to our house this coming Saturday night? We would like to go out to dinner with some grown-up friends!
I will weigh in briefly with my perspective from California. I can confirm that Phil’s understanding of the alimony and support issue is correct with respect to modestly high income people in California (>$200k per year). The plaintiff is almost always the woman at these income levels, who then has claim to essentially 1/2 the man’s income forever if the marriage lasted 10 years and 1 day. If the tax law is changed to make the man’s alimony payments non-deductible and the woman’s alimony receipts non-taxable, this would give the woman roughly 1/2 the man’s income in cash, and leave the man receiving 1/2 of his income pre-tax, and then being forced to pay taxes on the entire amount. You don’t have to be a mathematician to see how the woman ends up with a whole lot more after-tax income than the man.
Wives (and ex-wives) almost always claim that they are doing 100% of the child-care, housework, cooking, etc. And they claim 50% credit for the husband’s income, even when they barely know what the husband does for a living.
Let’s stone all the divorced people. Who do I vote for?
The initial text of HR1 says:
(c) Effective Date.—The amendments made by this section shall apply to—
(1) any divorce or separation instrument (as defined in section
71(b)(2) of the Internal Revenue Code of 1986 as in effect before the
date of the enactment of this Act) executed after December 31, 2017,
and
(2) any divorce or separation instrument (as so defined) executed on
or before such date and modified after such date if the modification
expressly provides that the amendments made by this section apply to
such modification.
Barring gross legal error it seems to me that there is no way to achieve “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.”
This sounds like a real disincentive to marry but wouldn’t the likely result of this be that alimony awards will be adjusted downward to take the new economics into account?
Jack, AMTbuff: I’m sure that state legislatures and judges will eventually update state laws and customs to reflect the new situation (after-tax child support revenue for the parent who can get hold of two children is 25 percent of pre-tax income in New York or Wisconsin, for example). My point in the original post is that there is likely to be an interim period in at least some states where plaintiffs can get alimony awards under a state’s old system and pay no taxes on the revenue under the Federales’s new system.
Judges will often apply laws and guidelines even when the result does not seem “just” to a layperson. So if the state provides for 50% of a defendant’s income as alimony on January 2, 2018, I don’t see why a judge wouldn’t award it. See
http://nypost.com/2017/07/23/man-ordered-to-pay-65k-in-child-support-for-kid-who-isnt-his/
http://www.nydailynews.com/news/national/okla-man-forced-pay-child-support-boy-isn-son-article-1.2946399
http://www.theroot.com/judge-orders-detroit-man-to-pay-30-000-in-back-child-s-1790858861
for example.
Now that I think about the American political process, I’m not sure that states would change their laws and guidelines. Taking the long view, being a divorce or out-of-wedlock child support plaintiff has become progressively (so to speak) more lucrative in the years since no-fault was implemented (1970s). By definition someone receiving alimony is “dependent” and therefore “vulnerable.” What politician wants to stand up and sponsor a bill to cut payments to the “vulnerable,” especially when those payments aren’t coming from tax dollars? You’ll never hear a politician ask “Why would an American go to med school and become a primary care doctor when the same spending power can be achieved by banging a married radiologist?” Should we expect them to stand up and say something against more lucrative alimony?
We have decades of experience to show that there is nothing impractical about having court orders that take away 80-100 percent of a defendant’s spending power. Although some family court lawsuit losers end up going to prison for non-payment (usually the ones who have been fired from their main job), most of the losers get second jobs, move in with relatives, etc., and keep paying so as to avoid prison. There is no significant political constituency that objects to these outcomes.
“There is no significant political constituency that objects to these outcomes.” Does it mean that American family is thriving and divorce is a rarity?
“Although some family court lawsuit losers end up going to prison for non-payment”
How many such individuals go to prison each year, and what fraction of lawsuit losers who don’t pay their child support or alimony do they represent? What is the range and average duration of their incarceration? Same questions for jail instead of prison.
“If plaintiffs are rational economic actors there will be a huge rush to the divorce courts as soon as this law goes into effect.”
This is true only to the extent that courts fail to adjust awards to reflect the new tax liabilities. If the awards are so adjusted, then I would expect the opposite effect on divorce filings.
These changes will increase tax collections in two ways:
1) The person paying the alimony is more likely to pay the required taxes than the person receiving the alimony because it is more likely their income is reported to the IRS whereas the alimony is not reported.
2) The person paying the alimony is more likely to be in a higher tax bracket than the person receiving the alimony.
These two effects would have the effect of reducing the total take home funds available for distribution between plaintiff and defendant. If courts adjust awards to reflect this new reality, then the effect would be to make divorce lawsuits less lucrative for plaintiffs and thus should reduce the incentive for filing one.
In a way this arrangement seems more fair to defendants since the plaintiff no longer gets to enjoy awards sized to reflect their nominal status as taxable income but which in actuality are tax free. However, my intuition tells me that at least some of the increased tax payments ends up on the defendant (I haven’t done the math) so even if it is more fair it may not be in the interest of defendants.
An alternative way to achieve collections increase (1) without tax rate increase (2) would be to require anyone claiming an alimony deduction to provide the taxpayer ID of the recipient and have the IRS verify that the alimony was reported as income by the recipient. Perhaps that’s off the table because it looks too much like work to the IRS.
Also, using the words “huge rush” is not really supported by the analysis in the posting.
Neal, all points you attempt to make about tax collections are undercut by your item 1) claim of “alimony is not reported”. Page 1 of IRS Form 1040, line 31a requires the alimony recipient’s social security number:
https://www.irs.gov/pub/irs-pdf/f1040.pdf
Steve:
I was going by “the successful plaintiff is statistically unlikely to report the $100,000 in income at all” as claimed in the original posting. Perhaps the IRS doesn’t cross check to verify the alimony was reported as income?
Steve: The IRS does print that box on the form. The Treasury folks have found that only about half the amount of alimony that is deducted by a loser is ever reported as income by a winner. See https://www.treasury.gov/tigta/auditreports/2014reports/201440022fr.pdf
Neal: “How many such individuals go to prison each year” There isn’t enough interest in this topic for anyone to gather comprehensive statistics, but http://www.realworlddivorce.com/PostDivorceLitigation cites a couple of studies and it seems that the number is somewhere between 2 percent and 14 percent of child support lawsuit losers being incarcerated in any given year (depending on the state). This may be complicated by the fact that some losers are imprisoned multiple times, e.g., Walter Scott was imprisoned three times before he had exhausted his usefulness to our society and the police shot him (see http://philip.greenspun.com/blog/2015/04/12/walter-scott-child-support-defendant-earned-about-800month/ ). Most of those imprisoned are low-income so nobody cares about them. See http://www.realworlddivorce.com/Maryland for a legislator’s take on the political dynamics. NYT wrote about this in 2015: https://www.nytimes.com/2015/04/20/us/skip-child-support-go-to-jail-lose-job-repeat.html
Divorce litigators in the winner-take-all states said that prison was an essential part of the system because nobody would ever voluntarily accept the “loser parent” role (give up house, children, and 50-70 percent of income going forward). That’s why we need to have court orders and prisons to back up the orders.
One thing that we were told is that plaintiffs may not want to send every defendant who is late on payments to prison, though this is easily done. A plaintiff can only get cash while the defendant is out working (paychecks automatically grabbed). So it makes sense to try to deal with the arrears once the children age out of the system (18 to 23, depending on the state) and then get the defendant imprisoned for non-payment of the arrears. We saw a lot of this in the Massachusetts court houses that we visited. Certainly every day at least one defendant is hauled off to prison. Most of the time the “children” that had led to the court-ordered cashflow were well over 18.
Anonymous #15: is divorce a rarity in the U.S.? It may become rare! Americans can realize a higher spending power by having sex with a high-income person and collecting child support than by entering into a marriage with a medium-income person. If people were never married they can’t get divorced! The U.S. provides the greatest financial incentives to get divorced and/or to have children without a permanent partner. Thus we have a much larger percentage of children living without two parents compared to other countries. See http://www.realworlddivorce.com/International for some data.
Almost half (45%) of married couples with kids under 18 have a household income of 100k/yr or more as of the most recent data year of 2016.
The overall trend for married households is their usually combined income increasing (a majority of married women work outside the home) compared to households without two married parents. This will probably have some implications regarding divorce in the coming decades.