The Tax Cuts and Jobs Act (TCJA), P.L.115-97, passed by Congress on December 22, 2017 affected numerous aspects of divorce.
The most talked about and probably most important change (in the domestic relations area) involves the deductibility of spousal support (alimony) payments and the taxable nature of support payments when received. Prior to enactment of the TCJA, alimony payments generally have been taxable to the recipient (under now-repealed Section 71 of the Code) and deductible by the payor spouse (under now-repealed section 215(a) of the Code).
The TCJA effectively reversed that treatment. As a result, for divorce or separation instruments executed after December 31, 2018, alimony payments will not be deductible by the payor spouse and will not be taxable to the recipient spouse.
The change also applies to payments pursuant to instruments executed before 2019, but only if the instrument is modified after December 31, 2018, and the modification expressly provides that the changes made by the 2017 Act apply. The new law also provides that ‘‘in the case of the remarriage of a parent, support of a child received from the parent’s spouse shall be treated as received from the parent.”
So, what does it mean to parties getting a divorce? The most obvious is that if the parties had not signed an agreement prior to December 31, 2018 that states that the obligor’s spousal support (alimony) payments are tax deductible to him/her and taxable to the oblige / recipient, then the payments are neither tax deductible nor income. Seems simple enough, right? But how do you make an order entered into after January 1, 2019 fair to both parties under the new law?
One might argue that if the payor spouse was paying (for example) $2,000/month on the basis that the payor received a tax deduction (reducing his after-tax outlay by $750 if he was in the 35% tax bracket), and the recipient paid $400 of tax (if she was in the 20% tax bracket), then the parties might adjust the monthly alimony to $1600/month, so recipient receives the same net amount ($1600), while the payor is a bit worse off (paying $1600 rather than the net $1250 under prior law). Perhaps a CPA could help calculate what would be the equivalent non-deductible payment by the payor and received by the payee. However, if the payor spouse is in a higher tax bracket than the recipient spouse (as usually would be the case), this is not likely to be a zero-sum gain situation, and there may be overall incentive to reduce the amount of alimony payments.
One interesting point is that the IRS has not yet issued any opinion letters on whether temporary support orders entered prior to January 1, 2019 will be tax deductible and or income thereafter when a final order that includes support is entered. This is a potential land mine for domestic relations attorneys.
Another important aspect of the new law is the impact on IRA contributions since one of the principal advantages of making contributions to a traditional IRA is the offsetting tax consequences. If the recipient spouse’s income consists solely of spousal support, then it appears that any future IRA contributions will no longer be tax deductible (as the recipient spouse would have no taxable income).
There is a definite impact on child tax credits. A child tax credit is a dollar for dollar decrease in taxes paid. Under the current law, a child tax credit is allowed up to $1,000 per child with a relatively low phase-out based on adjusted gross income. Under the TCJA child tax credits will increase to $2,000 per child but the phase-out levels are much higher starting at $200,000 for single filers and $400,000 for joint filers. Without getting into the weeds on how this works, the child tax credits will be more valuable as a trade-off.
For a child to qualify under the TCJA he/she must be under 17 years of age as of December 31st and he/she must reside in the same household as the parent claiming the child for more than half of the tax year. For children between age 17 and 24 there is a reduced child tax credit of $500 still available with certain caveats such as being a full-time student.
What about tax dependency deductions? The TCJA at §11041 suspends dependency exemptions beginning in 2018 and ending in 2025. The tax dependency deductions will return in 2026 unless Congress extends the TCJA exclusion. In the past, the dependency deduction was often used as a bargaining chip and as a trade-off for other economic consideration.
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