Divorce has always had tax implications, but with the enactment of the new Tax Cuts and Jobs Act (TCJA), some of the ways in which divorce and the tax code intersect have changed. If you are in the midst of a divorce, or contemplating filing for one, you need to be aware of how the new tax law affects divorcing couples.
As of this writing in early 2018, spousal support, also called alimony or spousal maintenance, is deductible from income by the person paying it, and taxable income to the recipient. Under the TCJA, this will change for divorces finalized in 2019 and later.
Alimony is paid in pretax dollars. If Chip makes $100,000 per year, and Dale makes $30,000, and Chip pays Dale $20,000 per year in alimony, Chip's taxable income would be $80,000 per year under current law, and Dale's would be $50,000. If their divorce is finalized in 2019 or later, Chip's taxable income would be $100,000 and Dale's $30,000 (ignoring, of course, any other exemptions or deductions either of them might claim).
It's almost always the case that the person paying alimony earns more money than the person receiving it, and is usually in a higher tax bracket. When alimony is taxed to the recipient, fewer taxes are paid on those dollars than if it is taxed to the payer, as it will be under the new law. The new law means more tax dollars flowing into government coffers, as alimony payments will likely be taxed at a higher rate. But it's a blow to those who will be paying alimony.
Under the old law, the tax deduction was an incentive for the higher-earning spouse to pay alimony, and the availability of alimony often served as an incentive to settlement for the lower-earning spouse. As a result, the tax rules regarding alimony promoted settlement and helped couples avoid a costly divorce trial. Under the TCJA, higher-earning spouses may be less willing to make generous offers of alimony in settlement negotiations.
Some in the legal community are wondering if there will be a "divorce boom" in 2018, with high earners who believe they will have to pay alimony scrambling to have a judgment before year's end to preserve their tax deduction. If you are a potential payer of alimony and are thinking about doing an end run around the new law by getting a divorce decree signed in 2018, then applying to have your alimony obligation modified downward in 2019, reconsider. The new tax law will apply to modifications of alimony that take effect in 2019 or thereafter, even if the original order for alimony was signed earlier. (In addition, there is no guarantee that the court would grant your request for a modification.)
Many people are confused by the difference between deductions, exemptions, and tax credits. Deductions and exemptions reduce the amount of income that is considered taxable. If your income is $50,000, but you have $10,000 in deductions and exemptions, your taxable income is $40,000.
Tax credits, on the other hand, directly reduce the amount of tax paid. "Refundable" tax credits are those that will result in a refund to the taxpayer if the credit reduces the amount of tax owed below zero. For instance, if you would have owed $600 in tax, but have a $1,000 refundable tax credit, you would pay no tax and would get a $400 tax refund.
Prior to the TCJA, couples might have bargained over who got to claim a dependent exemption for each child on their income tax return. For 2017, the last year for which the exemption was available, a taxpayer could exclude $4,050 of income for each dependent. As of 2018, that number is reduced to zero. However, that doesn't mean that the question of who gets to claim the kids as a dependent on their taxes is irrelevant.
The Child Tax Credit (CTC) has also undergone some changes.The CTC offsets, dollar for dollar, any taxes owed, and is partially refundable. It is available to taxpayers who have a child who is younger than 17 as of December 31 if that child lived with the taxpayer for at least half of the year, and the taxpayer claims the child as a dependent.
Previously, a taxpayer claiming the CTC could reduce the amount of income tax they owed by $1,000 for each qualifying child. That amount is increased to $2,000 under the TCJA, of which $1,400 is refundable. Depending on the number of children in a family, the ability to claim the CTC could be worth thousands of dollars.
Of course, there is more to your divorce settlement than how it impacts your taxes. To learn more about how your divorce will affect your finances in general, contact an experienced Maryland divorce attorney.
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