Thursday, January 10, 2019

What is the Right Percentage in Massachusetts for Post-Trump Alimony?

The Tax Cuts and Jobs Act (President Trump's tax reform passed at the end of 2018) ended the alimony tax deduction for divorce agreements starting on January 1, 2019.  For an explanation of this tax law change see our previous post: The Tax Cuts & Jobs Act of 2017 Includes a Divorce “Penalty”.

In Massachusetts our alimony statute includes a formula for calculating the maximum general term alimony in a divorce case.  However, this formula was created with the intention that alimony was tax-deductible to the payor and taxable income to the recipient.  Under §53 general term alimony is capped at the recipient’s “need” or 30-35% of the difference in the parties’ gross incomes.   Since the act was passed, the courts have clarified that “need” is a relative term and must reflect the parties' marital lifestyle in addition to other mandatory considerations contained in § 53(a).  For a more in depth analysis of the statute and subsequent cases, see our last post: The Alimony Reform Act: Lessons Learned in the Last Six Years.

Since that state law has not been amended by the federal tax law change, 
the question remains: should the formula percentages change?

While the alimony law does have provisions allowing for deviation from "from duration and amount limits for general term alimony" and there is a list of deviation grounds which includes "tax considerations applicable to the parties."  Some have asked why the burden in this situation should be on a payor to argue deviation grounds, but until the legislature makes a change to the statute or we get appeals court guidance at least we know that there is language in the statute that allows for the consideration of tax consequences.

In reality, no-one actually knows what judges are going to do until they do it (even the judge themselves in many cases).  This isn't meant to be insulting, but rather an acknowledgment that they are still human.  And none of us know (for sure) what the appeals court or SJC will do with this until the "right" test case is in front of them and they issue a decision.  Is the relevant question 30-35% vs. something else?  Or is the potentially more useful question to be answered whether the tax impact on the payor or the tax impact on the recipient should be the driving factor in determining the appropriate percentage?

Until we know, here is the humble opinion of the author as to a reasonable practical approach to address these questions:

The obvious purpose of the formula (30-35% of the difference) is to provide a range of likely need, to create a shortcut from actually determining "need" as defined in the statute, which is the alternative option for determining the cap.  It's meant to make it easier to settle without having to dig into marital lifestyle, budgets, etc.  The change in the tax law didn't change the need of recipients.  

It simply lowered what needs to be paid by a payor to meet that need, since the recipient no longer has to pay taxes on the receipt of those funds.  Therefore, the new shortcut should be relative only to the tax bracket of the recipient.  Of course, the impact of that payment on the payor (from net after-tax income) should still be a limiting factor when it comes to the payor's "ability to pay."  So, a sensible approach would be:

Step 1 - New Shortcut: Determine what amount would result in the same net payment as a taxable 30-35% of the difference in incomes to the recipient.  For example, in a situation where the payor has gross earned income of $250,000 per year and the recipient has gross earned income of $0, the statutory formula would result in a cap of "need" or $75,000 to $87,500 per year in alimony.  Under the old law this taxable income to the recipient would result in approximately $9,800 to $12,550 in federal income tax (assuming no itemizing or other deductions), reducing the available income to 26% to 30% of the difference in income.

These percentages will vary greatly with the amount of earned income that either party has, but the bottom line is that the after-tax net equivalent of 30-35% can be calculated.  The inquiry can stop there if both parties feel that that calculation is reasonable and reflective of their respective "need" and "ability to pay."  If either party questions this approach, or the resulting amount, then the shortcut was insufficient to reach settlement and you should proceed to step 2.

Step 2 - Define Need: Review the recipient's reasonable need based on their budget, and relative to the marital lifestyle at the time of divorce (as required by the Young case and the statute).  If the figure is different than Step 1, but the payor is still not comfortable with this figure then proceed to Step 3.

Step 3 - Define Ability to Pay: Review the payor's reasonable needs based on their budget, and relative to the marital lifestyle at the time of divorce.  If the figure is lower than the figure yielded by Step 1 or Step 2, then it is possible that marital lifestyle cannot be maintained by both people and some sacrifice is necessary to balance "need" versus "ability to pay".

When litigating this issue, a payor is going to focus on Step 3 and their "ability to pay", and a recipient is going to focus on Step 2 or try to argue the original formula.  The tax law change without any guidance (yet) from the courts means that there is a wider gap between each side's "best" and "worst" case scenarios in an adversarial approach.  This means that litigation expenses, the time to litigate, and the uncertainty of litigation will all be increased in these cases, which is all the more reason to try a mediation or a collaborative law approach.

Mediation and Collaborative Law are voluntary processes that give the couple control over their divorce and its terms. Settling outside of court allows a couple to discuss all aspects of their divorce, review different options, and decide what is best for their family, armed with the appropriate financial and legal knowledge.  When it comes to unknowns in the law, like how the court will deal with these new alimony questions, couples need to decide whether it's worth their time, money, and energy to be the test case, or whether it's more important to them that they find joint solutions in an efficient and effective process.

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