The tax reform bill currently making its way through the U.S Congress could have potentially seismic effects on California family law. The proposed legislation, which repeals itemized tax deductions such as medical expenses, state income taxes, attorney’s fees, and unreimbursed business expenses, calls for notable changes to the tax structure of spousal support.
The current proposed changes to the tax code shift spousal support tax responsibility. If passed, spousal support payments may no longer be (1) tax deductible to the payor, and (2) taxable as income to the recipient. These changes will have significant ramifications for individuals who pay or receive spousal support. This proposed elimination of “above-the-line” tax deductions on spousal support will undoubtedly cause a ripple effect on California family law. Let’s look specifically at the effect of eliminating tax deductions on spousal support.
In California, when calculating spousal support and child support, family law attorneys as well as the court often use the DissoMaster™ program, a computer program that determines child and spousal support amounts under the California Statewide Uniform Child Support Guidelines. The DissoMaster™ program is certified by the Judicial Council for use in all courts in California. A range of factors are inputted into the program in order to calculate spousal support. These factors include the parties’ monthly incomes, the percentage of custodial timeshare, the number of federal exemptions, and current tax deductions such as property taxes and mortgage interest.
Support Under Current Tax Laws
Under the current tax laws, spousal support is tax deductible by the payor, and taxable as income to the recipient. Child support offers no tax deduction and is a tax-free (non-income) payment.
Tax Reform and the Ramifications on Family Law
If the proposed tax reform passes, spousal support will no longer be tax deductible to the payor and will thus become tax-free income for the recipient. This will likely cause problems for both the payor of spousal support and the recipient.
In divorce negotiations, family law lawyers have been able to focus on the fact that spousal support is tax deductible to the payor. The payor is often in a higher tax bracket than the recipient spouse and the payor can utilize the tax benefit of a dollar-for-dollar tax deduction. The recipient spouse must file the spousal support payments as income and pay taxes on the total amount, but the recipient is often in a lower tax bracket and is often paying lower taxes.
These tax deductions and lower tax rates are often used as a means of making an economically beneficial settlement for both parties. However, if the proposed tax reform passes, this integral component in the family law lawyer’s arsenal will no longer be available.
Without the incentive of the tax-deductible spousal support, a payor may not be able to provide as much in spousal support. Furthermore, these tax reforms could also potentially hurt the recipients of spousal support because the payors may not be able to afford to provide as much in spousal support without the tax incentive that the spousal support payment will be tax deductible.
Though we will need to wait and see what happens with the proposed legislation over the next few weeks, it is important to recognize that this specific element of the proposed federal tax reform may cause a significant ripple effect for family law lawyers, judges, and parties in family law actions.