Tax Reform and Spousal Maintenance: Not All Bad News

In November 14, 2017, I wrote an opinion article which appeared in the Minneapolis Star Tribune regarding the elimination of the deduction for spousal maintenance on tax returns. At the time, the Senate’s proposed tax bill did not have this same provision. I was not sure how the House and Senate would reconcile their differences.

It’s Not Just Cinderella Worried About the Clock Striking Midnight

However, we know now the final tax bill passed in December 2017, included the elimination of the deduction for spousal maintenance on tax returns. However, the effective date is January 1, 2019 for any new decrees issued after January 1, 2019. In other words, the law will not affect current cases or future cases if the Judgment and Decree is finalized by December 31, 2018. I imagine 2018 will be a pressure cooker for many clients, attorneys and mediators as we try to reach agreements and finalize divorces before the clock strikes midnight on January 1, 2019. Not the Cinderella story most spousal maintenance payors were hoping for.

There May Be a Silver Lining

The elimination of the deduction for spousal maintenance payments is not the only provision that will affect individuals as they move through a dissolution proceeding in 2018. If you are a business owner (except service industry business owners such as accountants, financial planners, and attorneys) and report your business income as a pass through entity on your individual tax returns (solo proprietor, S-Corp, or partnership), then you may see a deduction up to 20% in taxes. The tax provision is complicated and has several limitations as to whether a business qualifies to take the 20% deduction. I am sure tax accountants will have a learning curve as they dive through the new Section 199A in the next several months.

You Will be Hearing More About Section 199A of the Tax Code

As a family law attorney, I believe Section 199A is important and relevant. How is this new section relevant to divorces? It is relevant for many of my clients who are business owners or clients who have spouses that own a business.

Currently, a business owner of a pass-through entity may pay as high as 40% in taxes. Under Section 199A, the highest effective tax rate will be lowered to approximately 29%. Congress, of course, imposed limitations on the amount of income eligible for the deduction ($315,000 for joint filers and $157,000 for single filers). The deduction may be important if a business qualifies for the 20% tax deduction because it may affect the after-tax cash flow available for families in determining spousal maintenance and child support.

How the 20% Deduction Could Increase Personal Cash Flow

In addition, today a spousal maintenance payment is deducted from the obligor’s income, and considered taxable to the recipient. As I stated in my Start Tribune article on November 14, 2017, the tax deduction is an important tool to increase the after-tax cash flow available to these families and their children. The 20% tax deduction for a business owner (who qualifies) may be an important tool to increase the after-cash flow available to families especially in light of the elimination of the deduction for payment of spousal maintenance. Of course, I realize that not all payers of spousal maintenance are business owners; however, for those who do own a business, this 20% tax deduction could prove to be important in calculating spousal maintenance and determining after tax cash flow available to support families and children, which would be a good thing.

It will be interesting to see how the pass-through entity deduction unfolds in the next few months and affects business owners’ after-tax cash flow.

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