In December of 2017, Congress passed the “Jobs, Jobs, Jobs Act,” formally known as The Tax & Jobs Act. This Act changed a number of long-standing provisions that have a direct impact on families including increasing the standard deduction and eliminating the personal exemption. There were a number of provisions that will affect families that are starting the divorce process. Going through a divorce is sometimes more about coping with the emotional toll of the experience but a financial toll can also be a factor as assets are being split and a new sense of financial stability takes a hold. Let’s take a couple minutes to understand how the new tax law may affect you financially as you are going through a divorce.
Taxes & Alimony
Under previous law, a payor spouse has allowed to deduct from his/her income tax, amounts paid to a payee spouse for alimony. The payor spouse was then required to include the amounts received in his/her income tax. The IRS strictly defined alimony in order to prevent a payor from attempting to treat amounts that should be considered child support as alimony in order to receive a larger deduction (child support is not deductible under current law). Under the new law, amounts attributable to alimony (also known as spousal support) which is included in any divorce decree or separation instrument, entered into after December 31, 2018, or modifications of previous agreements that include such a provision, will no longer be deductible to the payor or included in income of the payee spouse.
You may ask, how does this new provision affect me? The answer is quite simple, negotiation. Quite often in a divorce, no party wants to feel like they are giving up something without getting something in return. The ability to receive a deduction for amounts paid in alimony, especially to larger income spouse, could have an impact in being able to complete the divorce in a timelier manner. If a divorce can be finalized by December 31, 2018, then the spouse who will be the payor can retain the right to deduct alimony payments going forward versus holding out for what may be a lower dollar amount but losing the ability to deduct the amounts from income tax. There are various calculations that can be used to assist the parties in determining what financial advantage would be available for receiving the deduction. In addition, consulting with a tax attorney, in these negotiations, can help both parties understand the potential outcome.
In a divorce situation, it is quite common for both parties to wonder what is going to happen with their primary residence. Is the property going to be sold and the proceeds split? Is the home going to be maintained by one spouse who will continue to pay the mortgage or maintained by one spouse but mortgage paid by the other spouse? Each of these scenarios can have a different tax impact on both spouses so it is important to understand the potential tax implications.
Under current law, when a primary residence is sold and the home has been occupied as a primary residence for two out of the past five years then the proceeds of the sale may be excluded from income tax (Excludable amount: Single – $250,000 or Married – $500,000). The determination of whether you are married or single is based upon your marital status as of December 31st of that tax year. Selling the property prior to finalizing the divorce is the easiest scenario. If the property is not sold prior to the divorce and one spouse continues to live in the home for a period of time, advance planning should be taken in order to ensure that upon the sale of the home both parties are placed into the financial situation that they intended at the time of the divorce. There are a number of provisions that can be included in the divorce agreement that would allow the parties to have the appropriate tax situation that they envisioned.
Beyond the tax impact of selling a home now or in the future, there is another important consideration if a former spouse remains in the home and a mortgage is continually being paid. Under the new tax law, a taxpayer is able to deduct the interest on a mortgage up to $750,000 ($1,000,000 if the mortgage was entered into prior to December 15, 2017). The mortgage interest deduction is quite often the largest deduction that a party receives on their tax return and therefore appropriate planning should be made for who is entitled to claim this deduction in the applicable tax year. If both parties remain, payees of the mortgage, after the divorce, then appropriate documentation should be included with any tax filings indicating the amount that each former spouse is entitled to deduct. If only one former spouse is continually responsible for the mortgage payment due to refinancing or other arrangements than that former spouse should be entitled to the deduction.
Children & Taxes
For divorcing families with children, most parents are concerned with how they are going to split up parenting time, who is going to pay for medical care, and who pays for extra-curricular activities. However, an important consideration is the determination of who is going to claim the child(ren) for income tax purposes. The new tax law created three new considerations for divorcing families; increase in the child tax credit, reduction in the medical expense threshold, and the elimination of the personal exemption.
Under the new tax law, the child tax credit has doubled from $1,000 per child to $2,000 per child. The new law allows up to $1,400 of the credit to be refundable, meaning if you owe no tax then you could receive a refund. In addition, the law increased the maximum income limits of the taxpayer to allow more taxpayers to qualify for the credit (Income Limit: Single – $240,000; Married – $440,000). It is important to remember that the new tax law did not change the qualification criteria so it is important to keep in mind that a custodial parent can grant a non-custodial parent the right to claim the child by providing IRS Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent to the non-custodial parent to file their income tax return.
Under previous law, a taxpayer was able to claim certain medical expenses as an itemized deduction if the aggregated medical expenses that exceeded 10% of their adjusted gross income (7.5% if over 65 years of age). Under current law, for tax years 2017 and 2018, all taxpayers are able to claim a medical expense deduction for medical expenses that exceed 7.5% of adjusted gross income. IRS guidelines allow a non-custodial parent, who pays medical expenses for a child, even if the child does not live with them, to deduct the expenses on their personal income tax return. Medical expenses are a defined term but may include insurance, hospital, and doctor visits.
The last impact of the new tax law is the elimination of the personal exemption. Under previous tax law, a taxpayer was able to claim a personal exemption for themselves and each of their dependents (2017 personal exemption – $4,050). The current tax law has eliminated the personal exemption in favor of an increased standard deduction. The elimination of the personal exemption may negatively impact families with more than two children. In order to mitigate any negative impact due to this law change, it is going to be important in divorce negotiations to understand whether or not a parent may qualify as head of household thereby increasing the standard deduction available.
Having to deal with the stresses and emotions surrounding a divorce can already be a daunting task but not fully understanding the potential long-term tax impacts of your divorce agreement can be worse. It is important for divorcing couples to seek out the assistance of a tax professional to understand what the potential tax impact of a divorce may have on both parties. Robinson Legal is happy to provide valuable insight into each unique circumstance and help both parties potentially understand what lasting impact their divorce may have on their tax situation. #robinsonltd @robinson_ltd