In today’s mini episode, I wanted to cover some of the changes that were made to the tax code that I think are going to be relevant in divorce settlement negotiations. I want to talk about them in three different categories, and those are: (i) tax changes related to alimony or spousal maintenance, and (ii) those related to children, and (iii) those related to real estate.
Let’s take alimony first. As you may remember from Episode 16, when we talked about spousal support, typically, spousal support or alimony, spousal maintenance, I’m going to use those interchangeably, is deductible by the payor on his or her tax return, and it’s typically taxable to the recipient on his or her tax return.
What that means is that if the wife is the higher earner and is paying $20,000 a year in alimony to the husband, historically, the wife would get to take a $20,000 deduction from her taxable income on her tax return. That saves her money in taxes. Then the husband who is the recipient of that $20,000 in alimony, he has to add $20,000 to his taxable income on his tax return, and he has to pay taxes on that income.
For a very long time, and I don’t know how long it’s been, but for as long as I’ve been practicing, that’s been the way that alimony has been dealt with.
Sometimes people would choose to contract out of that, meaning they would say in their agreement, “Well, actually in our case, alimony is not going to be taxable to the recipient and it’s not going to be deductible by the payor.” But much more common than not is that alimony was a tax deduction for the payor and it was taxable income to the recipient.
And why? Because the payor, by definition, is the higher earning spouse. Often, if they’re the higher earning spouse, that means that they are paying a higher tax rate on the top dollars of their income than the lower earning spouse is. So by getting to reduce the amount of alimony paid from the payor’s taxable income and shift it to the recipient’s taxable income, there was some amount, not massive but some amount, of tax savings. I hope I haven’t completely lost you there.
Let me shift now to talking about what the change is. The change in the tax law is that as of January 1, 2019, alimony is no longer going to be a tax deduction, it can’t be deducted by the payor, and it’s no longer taxable to the recipient.
And when I say “as of,” by that I mean, for agreements and divorces that are signed on January 1st2019 or after. So, if you have your agreement or your divorce that is signed prior to January 1st2019 and you have alimony in it and you want to make it deductible by the payor and taxable to the recipient, you can still do that.
Obviously, as goes for everything that I ever say in this podcast, please talk with your mediator and/or your divorce attorney and, most importantly, with your accountant about this. But that’s the update on alimony. It used to be deductible, taxable. Now going forward, as of 2019, it’s not going to be deductible. It’s not going to be taxable, unless you have an agreement or a divorce that was signed prior to 2019, in which case you’re basically getting grandfathered in to be able to deduct alimony and to have to pay taxes on alimony.
The second category of tax-related changes in this new tax law relates to kids. And one of the things that we used to negotiate in a divorce agreement was who would be entitled to take the dependency exemption related to each of the children.
And as you may remember from our episode on taxes, that’s something that can be traded between parents. By the tax code, a certain parent is entitled to take the dependency exemption, but that parent can choose as part of the negotiation, and through signing a form called Form 8332, they can choose to transfer the entitlement to claim a child as a qualifying dependent and claim the dependency exemption related to that child. They can transfer that to the other parent.
Well, the dependency exemptions have been eliminated, I think, until 2025. Again, please check with your accountant on this. This is just very basic, almost lay person, level of knowledge of changes in the tax code, but I just want to flag them for you. So negotiating around trading the dependency exemption is no longer going to be relevant at least for the next seven years or so.
What has happened related to children is that the child tax credit was increased and the level of income at which that credit is phased out or you don’t get that credit has also been increased. I’m not going to go into the details there. Frankly, I don’t know them off the top of my head. But please talk to your accountant about that. And I would imagine for divorce purposes that now the child tax credit, which used to be basically ignored because oftentimes the couple who was negotiating had income in excess of that which would allow them to qualify to use the child tax credit, now maybe that’ll be on the table a bit more in divorce negotiations.
The other big change I want to mention is that the rules around 529 accounts have been liberalized. So instead of just being eligible to use your 529 money toward college, now families are eligible to use up to, I believe it’s $10,000 a year per student, for private K through 12 education, which did not used to be the case prior to this new tax law.
That may as well be something that comes up in a divorce negotiation or just something for you to be aware of as well, if you have 529 accounts and children in private school, something for you and your spouse or you and your ex to talk with your financial planner and your accountant about how to use most wisely.
The third category of changes in the new tax law that I think will impact divorce negotiations is related to real estate.
First of all, there’s this new cap of $10,000 on the total amount of deductions that you can itemize for state and local taxes paid, including property taxes. If you were itemizing deductions and you were including your property taxes paid on your residence, this change is something you want to take into consideration.
For instance, if you’re thinking that you’re going to be keeping the residence and you’re imagining “Okay, great. And I’ll be able to deduct x amount of dollars in property taxes,” well, it’s capped at $10,000 now, and that includes your state and local income tax deduction as well. So please talk with your accountant about this. But I do think that that may change some of people’s own calculations about how financially feasible it is to remain in the home. It may also impact people’s future buyers’ thinking about what they’re willing to pay for a home if they know that the property taxes are high but they can only deduct up to $10,000 a year of them mixed in with state and local income taxes, as well.
The other big change related to homes is that for mortgages in excess of $750,000, you can no longer deduct the interest that you pay on your mortgage for the principal above $750,000. I believe the cap used to be $1 million and they lowered it to $750,000 of mortgage principal that you are allowed to itemize and deduct your interest payments made on.
And so, again, that could impact your thinking about what kind of a tax deduction you’re going to be entitled to if you retain the marital home. It could also impact future buyers’, future purchasers’ thinking about “Okay, well, if I need to have a mortgage of $1.25 million, $500,000 of that mortgage, the interest that I pay on it won’t be deductible.” And maybe that’ll impact their thinking about how to value your residence when they’re purchasing it.
That is a quick summary of three categories of changes enacted into law in 2017 but that are being made to the tax code and going into effect in 2018, and in the case of alimony, in 2019.