The Republican tax plan imposes a new divorce tax penalty

  • The Republican tax plan would impose a new tax penalty on divorce.
  • The change would allow the government to collect more than $US8 billion in new revenue over 10 years.
  • But it would make both parties to a divorce pay much more than they currently do.

The Republican tax plan hasn’t met the expectations of advocates for “family-friendly” tax reform. Its child credit provision is disappointingly small, in the eyes of Sen. Marco Rubio, and it abolishes the adoption tax credit altogether.

But there is one provision that could be construed as “pro-family”: A tax penalty for divorce.

The tax bill released Thursday would change the tax treatment of alimony. Currently, alimony is tax-deductible for the paying spouse and taxable to the receiving spouse. But if you get divorced after the plan is enacted, that would change: Alimony would be paid out of after-tax dollars, and would be tax-free to the recipient.

This change would tend to increase the total amount of tax paid by divorced couples, since the ex-spouse who pays alimony is typically the one with the higher income who faces a higher tax bracket.

The bill summary for the tax plan offers this argument:

“The provision would eliminate what is effectively a ‘divorce subsidy’ under current law, in that a divorced couple can often achieve a better tax result for payments between them than a married couple can.”

That’s true for some ex-couples, particularly those who have relatively equal incomes. But if you and your ex-spouse have relatively equal incomes, there’s probably not a substantial alimony payment between the two of you anyway.

For couples where one spouse makes much more than the other, the situation where you would expect substantial alimony, this change doesn’t eliminate a divorce tax bonus. It creates a divorce tax penalty.

All told, the change would lead to the federal government collecting an additional $US8.3 billion in taxes from divorced couples over the next 10 years, according to the bill summary.

Alice and Bill Smith get divorced and face the divorce tax penalty

Consider a happily married couple, Alice and Bill. Bill makes $US80,000 a year as an engineer; Alice, a struggling artist, makes $US20,000.

Alice and Bill have no children. Under the Republican plan, they would take the standard deduction of $US24,000 and have a tax bill of $US8,520.

Their taxes are fairly modest in part because, under the Republican plan, married couples face a tax rate of 12% on the first $US90,000 of taxable income, and only $US76,000 of their income is taxable. They also get $US600 in “family flexibility credits.”

Then Bill has an affair with Carol. Alice finds out and demands a divorce.

Now Bill is a single man with an income of $US80,000. His tax bill is now $US10,850  — more than the couple’s combined tax bill when they were married, because for a single person, the 12% tax bracket only covers the first $US45,000 of income. Now, a lot of Bill’s income is taxed at 25%.

Alice’s tax bill is much more modest  — just $US660 on her income of $US20,000. Bill is paying her $US15,000 a year in alimony on top of that, but she doesn’t pay any tax on it.

All told, Alice and Bill are now paying $US11,510 in federal income taxes, a 35% tax increase over when they were married  — plus, they have to maintain two homes. Sad!

Maintaining the existing alimony rules would save Alice and Bill a lot of money

Imagine instead that Bill was able to pay Alice alimony on a pretax basis, the same way it’s done today. In this scenario, we’ll increase her alimony payment by 15% to $US17,250, to reflect the fact that she’ll be the one paying the taxes on it.

In this scenario, Bill’s income less alimony is $US62,750, and his tax bill is $US6,538. Alice’s income including alimony is $US37,250, and her tax bill is $US2,730.

That means their combined tax bill would be $US9,268  —  only 8% more than when they were married, and nearly $US2,000 less than under the Republican plan.

Arguably, imposing such a substantial tax penalty on divorce could encourage people to stick it out and make their marriages work. But it could also financially trap people in unhappy marriages.

This rule also would seem to violate the “ability to pay” principle of taxation.

The whole reason the tax code offers higher tax bracket thresholds to married couples than single people is that a married couple’s income has to support at least two people. If you’re divorced, and one ex-spouse’s income is being used to support the other ex-spouse, that’s an income that’s still supporting two people. But this plan would subject that income to tax brackets designed for a single person.

This doesn’t seem very nice.

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