While I am by no means an expert in tax law or a tax attorney, nor do I intend this brief article to provide legal advice, I write with the hope of highlighting some of the impact the Tax Cut and Jobs Acts (TCJA) will have on people going through a divorce. I offer the following in an attempt to break down the recent change in tax law in very broad strokes. In my humble opinion, the portions of the TCJA that will have the most dramatic effect on divorcing couples are tax liability going forward and the impact of the tax treatment of alimony.
TCJA & Alimony
Up until 2018 Uncle Sam was not getting his full share of taxes on alimony payments between divorced individuals, if the parties were in different tax brackets. Prior to enactment of the TCJA the payor of alimony would receive a deduction for alimony payments and the receiver would pay tax on the alimony received. While Uncle Sam would have been kept whole if the payor and receiver were always in the same tax bracket, this was (is) rarely the case. In a typical divorce (good luck trying to define what a typical divorce is) the payor of alimony is usually in a higher tax bracket than the receiver of alimony. It was the tax treatment caused by the different brackets that would often help convince the payor of alimony to pay a higher amount of alimony than he or she wanted to because the net impact of the money paid was greatly reduced by the former tax reduction.
To illustrate this point, let’s say that prior to the TCJA a husband in the 40% tax bracket had agreed to pay his ex-wife, who is in the 25% tax bracket, $50,000.00 per year in alimony. The husband would have received $20,000.00 in tax deductions while the ex-wife would have to pay $12,500.00 in taxes on the alimony she received; leaving $7,500.00 that Uncle Sam could not get his greedy little claws on. The husband would have actually paid a net alimony of $30,000.00 for the year ($50,000.00 – $20,000.00 tax deduction), while the wife would have received net alimony payments of $37,500.00 for the year ($50,000.00 -$12,500.00 in taxes). Therefore, the wife’s attorney could correctly tell the husband’s attorney that $50,000.00 in alimony would only cost the husband $30,000.00.
Since enactment of the TCJA the payor is no longer able to claim a deduction for alimony paid, and the receiver does not have to pay taxes on alimony received. This is a permanent change that is not set to expire in 2025. A likely outcome of the TCJA is that payors of alimony will not agree to pay monthly alimony amounts as high as monthly payments made before the TCJA. Using the husband from the above example, before the TCJA his $50,000.00 per year in alimony actually cost him $2,500.00 per month ($50,000.00 – $20,000.00 deduction= $30,000.00 paid/ by 12 months). Under the TCJA if the same husband were paying $50,000.00 per year in alimony it will now cost him $4,166.67 per month ($50,000.00 /12 months). It is logical to conclude that the TCJA will make negotiations in regard to past levels of alimony payments much more difficult.
Personal and Dependency Exemptions
Prior to implication of the TCJA personal and Dependency exemptions were $4,150.00 for the 2018 tax year. A person in the 30% tax bracket would have received about a $1,245.00 exemption. Divorcing parties with children would often negotiate who would receive these exemptions for the couple’s minor children. A parent with more dependent exemptions will receive more favorable tax treatment when it it is time to settle up with Uncle Sam at the end of the year. For 2019, and going forward, these exemptions have been removed. The TCJA has not abolished personal and dependency exemptions, but has reduced them to zero. However, if you can just stay married until 2025 you may be able to get personal and dependency exemptions again (sarcasm intended). However if you do stay married in the hope that you may be able to claim personal and dependent exemptions in 2015 you may have waited in vain. While many provisions of the TCJA are set to sundown in 2025, there is a chance that Congress may choose to extend all of or some of the provisions of the TCJA. So, your wait to delay your divorce may be in vain if it is based solely on tax law.
Although the dependency exemption is effectively gone a savvy lawyer will still have language in his or her Settlement Agreement allocating who is to receive the exemption, especially for clients with young children. Remember 2025 is only 6 years away, and acting with punctuality is not something Congress is noted for. A well drafted Settlement Agreement should contain language stating which parent will receive the exemption, for which child or children they will receive the exemption for, and for what tax year(s) (odd, even, or every) the parent will receive the exemption; while including the language “if available”. Clients are done a disservice if their agreements are not drafted and created to plan for several contingencies and last many years.
Child Tax Credit
While the dependency exemption is gone at the Child Tax Credit has been increased. TheTCJA has actually increased the Child Tax Credit from $1,000.00 to $2,000.00 per child. This is a valuable item for parents as a tax credit is a dollar for dollar reduction in tax liability, while an exemption is a fractional reduction. Therefore, a well drafted Settlement Agreement will also contain provisions for allocation of the Child Tax Credit and designate how each parent will be able to use it.
TCJA Does Not Apply to Divorces Before December 31, 2018
The TCJA applies to any divorce or separation agreement executed after December 31, 2018. So alimony provisions executed prior to December 31, 2018 will receive tax treatment as before the TCJA. When modifying an alimony agreement that was executed prior to December 31, 2018, the tax treatment will be the same as before the TCJA, unless the parties include language that expressly states that the amendments of the TCJA apply to the modification. A prudent practitioner may choose to add language to a modification of an alimony agreement that was executed before December 31, 2018 and modified sometime thereafter that states that the parties agree that TCJA does not apply and will indemnify each other if the parties’ tax treatment is affected by the modification.
While this article only highlights a few provisions of the TCJA there are many more provisions that will have a direct impact on tax liability. A wise person is best served by consulting a tax professional to see how the TCJA will impact them, and how to best reduce their liability.
Donato “Dan” Palumbo is a partner with Palumbo Law LLC. He specializes in all aspects of divorce and family law, DUI and criminal law. Dan graduated cum laude from Pace Law School, and has been admitted to practice law since 2010. Dan was a professional firefighter in New York before becoming an attorney. Dan is licensed to practice law in the State of Georgia and State of New York; and retired from the practice of law in Connecticut and the District of Columbia. You can learn more about Dan and Palumbo Law by visiting www.mycousindanny.com , www.palumbolawga.com, www.undomymarriage.com or contact him directly at firstname.lastname@example.org.