With the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017, most people have heard about the changes in tax brackets, the elimination of exemptions, the reduced tax rate for corporations and the qualified business deduction for certain passthrough entities. For those in the midst of divorce, or contemplating a divorce, the TCJA adds some additional complications to what is often already a complex financial settlement.
Prior to the TCJA (and for divorces finalized before January 1, 2019), the payment of alimony was deductible by the payor and taxable to the recipient. For all divorces finalized after December 31, 2018, spousal maintenance is neither deductible by the payor nor taxable to the recipient.
A spouse ordered to pay alimony of $50,000 in 2018, will receive a reduction on his/her 2018 tax return of that same amount. Assuming the payor taxable income would have been $250,000, the reduction of alimony brings taxable income to $200,000. Assuming the payor is now claiming single status for tax filing purposes, the deduction of alimony reduces their 2018 taxes by $17,500. If the divorce is not finalized until 2019, the payor will receive no deduction from income and will pay the $50,000 in alimony plus tax on $250,000 of income. Timing will be a factor this year in divorce settlements.
While not being taxed on the alimony received may sound good, it is likely the payors will be negotiating for lower amounts of alimony since they will not be receiving a tax reduction.
Dependency exemption/child tax credit
Beginning with tax year 2018, the TCJA eliminates the dependency exemption for all individual taxpayers. Does this mean divorcing couples no longer need to worry about who gets to claim the kids? No – not at all. Now the importance of who claims the children as dependents isn’t about the exemption but about the potential child tax credit.
The TCJA raised the potential child tax credit from $1,000 per child under the age of 17 to $2,000. This is a dollar for dollar reduction of income tax, not a deduction from income. In addition to the $1,000 increase in the credit amount, the thresholds for phasing out of the credit were raised. Prior to 2018, the child tax credit began to phase out for single taxpayers who had an adjusted gross income of $75,000 or more ($110,000 for married taxpayers). Beginning in 2018, the phase out begins at $200,0000 for single taxpayers ($400,000 for married taxpayers). This means many more taxpayers will be eligible to claim the child tax credit than in previous years.
Often, part of the negotiation of a divorce settlement is who gets to claim the kids. This may become more of an issue to some taxpayers who now find themselves eligible for the increased credit.
Melissa E. Loughlin-Sines, CPA, CFE, CVA, CFF, ABV