The 2017 Tax Cuts and Jobs Act is the most sweeping update to the U.S. tax code in more than thirty (30) years. The recently released bill would lower taxes on businesses and individuals and unleash higher wages, more jobs, and untold opportunity through a larger and more dynamic economy. How will these changes affect divorcing couples?
These tax changes sunset in 2025. All marital settlement agreements with minor children should include proper language to handle changes if/when tax laws change.
1. ALIMONY (also referred to as maintenance) will no longer be tax deductible or taxable to divorcing couples.
This new treatment of alimony and the amendments made by Section 11051, Repeal of deduction for alimony payments shall apply to:
a. any divorce or separation instrument (as defined in section 71(b) (2) of the Internal Revenue Code of 1986 as in effect before the date of enactment of this act) executed after December 31, 2018 and b. any divorce or separation instrument (as so defined) executed on or before such date and modified after such date if the modification expressly provides that the amendments mad by this section apply to such modification.
The elimination of the tax deduction to the higher paying spouse and the taxability of the income of the lower paying spouse is expected to be a huge revenue boost for the Internal Revenue Service (IRS) overall.
It will affect divorcing couples in several ways.
- Overall families will pay more in taxes.
- Families will no longer have the ability to move money from a higher income tax bracket to a lower bracket.
- Upfront alimony or maintenance buy-outs will no longer need to be tax effected.
- Professionals will no longer have to worry about alimony recapture.
- It will be simpler to utilize “family support.” (bundled support for alimony and child support payments).
The question that comes to mind is: How will the IRS know when a person is “divorced?”
The Definition of Divorce or Separation Instrument:
For purposes of this paragraph, the term divorce or separation instrument means the following:
- a decree of divorce or separate maintenance or a written instrument incident to such a decree,
- a written separation agreement, or
- a decree (not described in clause (i) requiring a spouse to make payments for the support or maintenance of the other spouse.”
There MAY not be a requirement to have a final decree by December 31, 2018 in order for current laws to apply. The MAY only need to be an executed “Divorce or Separation Agreement”.
THE IRS HAS NOT YET ISSUED OFFICIAL GUIDANCE AROUND THIS ISSUE.
So what does the term executed mean – when the agreement is signed by the parties? Does the term executed mean when the agreement is incorporated into the decree? Without specific guidance by the Service, I would not plan on the signature date being the date executed (and this might also depend on State law). The only way that one can deal with this issue until guidance is issued is the date executed should be the date signed – specify a dollar amount that is anticipated to be taxable as alimony and then add another sentence which states that if the above is later determined not to be taxable and deductible, a different dollar amount will be paid which is not taxable and deductible.
Some CPAs think the divorce must be finalized by the court by December 31, 2018 in order for maintenance to be deductible.
Some CPAs think a signed separation agreement (or marital settlement agreement) is enough. We will not know for sure until the IRS issues official guidance. In order for maintenance to be tax-deductible alimony are that they must be pursuant to a “divorce or separation instrument”.
Section 71(b) (2) Section 71(b)(2) of the Internal Revenue Code defines a “divorce or separation instrument”. As that section of the Code says, a separation agreement qualifies as a “divorce or separation instrument”. Therefore, so long as the separation agreement is signed on or before December 31, 2018, regardless of when the dissolution or legal separation decree is entered, the maintenance MAY qualify as tax-deductible alimony under the current law.
In fact, you MAY not need a legal proceeding or decree for maintenance to qualify as tax deductible alimony. All you MAY need is a written instrument (e.g. a separation agreement) providing for the payments, with clear language that the payments are intended to be tax deductible alimony and are not child support. The parties do need to be separated (“not members of the same household”). So, a couple could possibly be separated for an extended period of time, never file for divorce, and have tax deductible maintenance payable by one to the other pursuant to a separation agreement.
Please refer to IRS Section 11051, Repeal of deduction for alimony payments.
2. Filing Status: Head of Household v. Single Filers: 2018 Tax Brackets for Head of Household and for Single Parties-Incomes at $157,500 and higher are the same tax rate.
This is especially important when running child support guidelines.
Standard Deductions- There are no longer certain personal exemptions
Single exemption is $12,000 versus $6,350 in 2017
Head of household is $18,000 versus $9,350 in 2017
Married Filing Jointly is $24,000 versus $12,700 in 2017.
3. DEPENDENCY EXEMPTIONS: The Child Tax Credit doubled to $2,000 per child from $1,000 per child and phases out at $240,000.
The Child Tax Credits reduce tax bill whereas the dependency exemption, which is no longer available, reduced taxable income. The Child Tax Credit is more valuable than before. It is also now available to higher income earners. The parent can only take the child tax credit if the child is NOT yet 17 on December 31st of the calendar year. Therefore, it is even more important to negotiate who should get it.
4. ITEMIZED DEDUCTIONS:
- State and local taxes are now limited to $10,000. This is important for high property tax payers.
- Mortgage interest is still deductible but new mortgages are capped at $750,000 and old mortgages at $1,000,000.
- Interest on home equity lines of credit (HELOC) are not deductible for old and new HELOCs, unless it was used for home improvement.
- Charitable contributions are still deductible.
- Miscellaneous deductions have been repealed.
- No phase out for high-income earners.
5. 529 PLANS. 529 Plans can now be used for private school (and homeschool) – elementary through high school up to $10,000, which will be the maximum payment per child per year (not including college).
This is a good idea for clients with kids in private school. Check your local state laws!! Lump sum funding – allows tax savings and non-taxable growth. Don’t overfund because this all sunsets in 2026.
As with the other tax changes, the Child Tax Credit sunsets in 2025. All marital settlement agreements with minor children should include proper language to handle changes if/when tax laws change.
Please contact me and I will gladly send you language for agreements addressing the tax credits. email@example.com
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