How the Tax Law Changes Will Impact Divorce

The Tax Cuts and Jobs Act (TCJA) will impact many areas of our financial lives. However, there is one area of particular importance to many: divorce. I believe the new tax laws will make a divorce more expensive and more complicated, at least in the short-term. However, there are certain upsides and planning opportunities.  

The tax law changes will impact individuals getting divorced in at least three important ways: changes to the taxation of alimony (also known as spousal support or spousal maintenance), reduction in itemized deductions, and changes to the child tax credit. Let's look at these three individually. 

Alimony

Under last year’s tax law, alimony was tax deductible to the payer and taxable income to the payee. Because the payee is usually the lower income earner, this system often benefited both parties. The higher earning spouse could afford to give more to the lower earning spouse because, after the tax deduction, their net cost would be lower. Also, this shifting of income created a situation where both spouses cumulatively paid less in taxes than they otherwise would (holding all other factors constant). 

Under the TCJA, alimony is no longer tax-deductible nor taxable income. The good news is (and where the planning opportunity lies) that this provision of the tax law will not become effective until 12/31/18. So, for divorces signed before the end of 2018, alimony will still be tax-deductible to the payor and taxable income to the recipient, assuming all necessary conditions are met. 

This delay should create an opportunity for spouses on either side of the divorce to evaluate when they want the divorce to be finalized. The higher earning spouse will most likely want a divorce to be finalized this year, while the lower earning spouse may want it delayed until 2019. 

Itemized Deductions

Most expenses related to a divorce are not tax-deductible. However, the few that were have effectively been eliminated by the TCJA. Legal fees attributable to the collection of alimony used to be deductible under miscellaneous itemized deductions (Schedule A). Same goes for tax advice related to a divorce. However, under the TCJA, miscellaneous itemized deductions have been eliminated. And thus, so too have these two divorce-related deductions. This change, unlike the alimony provision, is effective for tax year 2018.  

Child Tax Credit

Beginning in tax year 2018, the child tax credit will go from $1,000 per qualifying child to $2,000 per qualifying child. And the income limitation to claim the full deduction will increase from $75,000 for single filers ($110,000 for married filing jointly), to $200,000 ($400,000 for married filing jointly).

The child tax credit can be an important negotiation tool in a divorce and possibly more so now. Credits are more powerful when it comes to taxes than deductions, because credits reduce the amount you owe dollar-for-dollar (rather than just reduce taxable income as deductions do). By default, the credit goes to the custodial parent. However, the custodial parent can assign the benefit to the non-custodial parent.  

Final Thoughts

The bad news is divorce just got more difficult. The good news is that you don't need to know everything or go it alone. Surround yourself with an experienced team of professionals. This may include a specialized divorce attorney, a financial planner trained in divorce planning, and possibly a tax advisor. 

Breakwater Financial, LLC is a registered investment advisor. The content of this blog post is for informational and educational purposes only and is not to be considered investment advice. If you have any questions regarding this Blog Post, please Contact Us.