FALL 2018: The Impact of the Tax Cuts and Job Act on Family Law Cases

By Marc Bello and Jason Pierce

On December 22, 2017, the Tax Cuts and Job Act (“Act”) was signed into law. Although initial efforts for tax reform have been in the works since 2016 very little progress made its way into the lime light until September 2017. This short timeframe produced the first major tax overhaul since the landmark 1986 tax act.

The Act has a direct and indirect impact on Family Law. This article highlights major tax changes and how to consider them for divorces in the current year and beyond. To add to the uncertainty, some of the law changes which affect divorcing parents with young children are scheduled to sunset in tax years after December 31, 2025. The following chart illustrates the key provisions.

The main features of the Act affecting family law cases which center on divorcing parents with dependent children include suspension of dependency exemptions and changes to the child tax credit. In addition we will also discuss the impact of non-deductible/non-taxable alimony.

Dependents

The dependent changes involved the elimination of the personal exemption and the increases to the Child Tax Credit. Before we get into the details of what’s changed, it’s important to review what did not change. For example, the definition of a dependent child has not changed and neither has the ability for the custodial parent to release a dependent child.

The following chart illustrates the factors which relate to claiming the dependent(s).

In order to release a dependent to the former spouse, the following should be considered:

The loss of the dependency exemption will likely have a negative effect on the amount of tax due whereas more taxpayers may be able to subsidize this loss with an increased benefit from the Child Tax Credit. Individuals who may qualify for the child tax credit increased from an initial phase out of Adjusted Gross Income (“AGI”) from $75,000 for single filer and $110,000 for head of household filers to an adjusted gross income of $200,000 for both single and head of household filers.

The amount of the refundable credit, which is a dollar for dollar credit against income taxes due increased from $1,000 to $2,000. To qualify for the $2,000 Child Tax Credit the qualifying child must be under 17 years of age. A $500 non-refundable credit is available for older qualifying children. There is also a provision which may allow a refundable credit up to $1,400 per child. The credits continue to be reduced by $50 per every $1,000 over the adjusted gross income thresholds.

Alimony Repeal

A second issue affecting divorce cases which is creating the strongest stir among the family law community is the repeal of tax deductible alimony by the payor and taxable alimony to the recipient. According to the 2015 Statistics of Income line item estimates published by the Department of the Treasury Internal Revenue Service1 , based on individual income tax returns identifies the differences between taxpayers reporting receipt of alimony compared to those taxpayers claiming the deduction of alimony. The chart on the following page illustrates this disparity.

The chart above reveals that approximately one third of tax payers who receive taxable alimony are not reporting the amount on their respective tax return. Though it was known the House and Senate were looking to find tax dollars as much as find tax savings the disparity identified above was not the rational in the Tax Cut and Jobs Act (“TCJA”) used for the repeal of deductible/includable alimony. The Act referenced a 1917 case Gold v. Gold which stood for the premise that alimony was not earned income and therefore should not be taxable.

The tax changes related to alimony were postponed until December 31, 2018, however it is not that straight forward. As stated in the Act, the effect of non-deductible alimony is “effective for any divorce or separation instrument executed after December 31, 2018, and modified after that date, if the modification expressly provides that the amendments made by this section apply to such modification”

During the current year to preserve the deductibility/taxability of alimony by executing a divorce or separation instrument before the end of the year. Within the Internal Revenue code a divorce instrument means (a) a decree of divorce or separate or maintenance or a written instrument incident to such a decree; (b) a written separation agreement; or (3) a decree (not described in (a)) requiring a spouse to make payments for the support or maintenance of the other spouse.

The third aspect is modifications. Any modifications to the divorce or separation instrument if executed before December 31, 2018 and then subsequently modified after December 31, 2018 must elect to adopt the amendments under the Act.

What are the financial ramifications of alimony becoming non-deductible and non-includible? The following example shows what the overall impact of non-deductibility of alimony is as compared to the past.

Fact Pattern:

  • Divorcing Couple:
    • Spouse #1 earns: $75,000
    • Spouse #2 earns: $350,000
    • Alimony award $89,375 (32.5% of difference)
    • Other Factors:
      • Residence to be maintained by Spouse #1
      • Real estate taxes $8,000
      • Mortgage Interest $15,000

Step 1: How things looked prior to the effective date of the Act: (Based on alimony of $89,375 per year)

Step 2: Compare alimony of $89,375 as if deductible to then nondeductible

Without changing the alimony percentages the recipient would now have more after tax income than the payor. What may be required is an additional reconciliation to determine the benefit/detriment and see if any adjustment is necessary. This process is outlined in Step 3.

Step 3: Adjusting the percent to account for payor paying all the taxes and loss of combined overall income.

This article is not meant to be a comprehensive analysis of the Act. Rather, we have highlighted some of the key features which is likely to affect family law cases. There are other aspects of the Act which may affect your case, especially if it involves a business valuation. The new changes are substantial and will likely require a detailed analysis for each situation. We recommend you involve a qualified professional when drafting separation agreements and support orders to comply with all the nuances affecting your clients.


[1] Individual Income Tax Returns Line Item Estimates, 2015. Publication 4801 (Rev. 9-2017) Department of the Treasury Internal Revenue Service

Marc D. Bello, CPA/ABV, CVA, MAAF, CFF, MST has been a partner at Edelstein & Company since 2002 and is the leader of the Business Valuation and Forensic Accounting Team.

Marc is a nationally recognized expert in business valuation and forensic accounting. He has appeared as an expert witness in the United States Tax Court as well as Massachusetts Superior Courts and Probate Courts. Attorneys seek Marc’s expertise in the area of litigation support, serving as an expert witness in the areas of business valuation, forensic accounting, complex compensation issues, lost profits, business interruption, economic damages and taxation. Marc is highly valued because of his ability to present and explain in a clear and compelling manner the often complex facts involved in high stakes disputes.

Marc regularly provides business valuations in the context of marital dissolution, shareholder and partner disputes, financial reporting, gift and estate planning, business planning and decision-making.

Marc has authored numerous articles related to divorce, forensic accounting, and family business operations. He is a frequent lecturer on issues of business valuation and forensic accounting at conferences around the country.

Jason Pierce, CPA, CMA, CFM, CVA, MAFF is a principal with the firm Edelstein & Company LLP. Prior to moving to Massachusetts, he was a partner at an Alaskan CPA firm and a valuation manager for an RSM McGladrey network firm. Jason specializes in conducting business valuations and financial forensics for gift and estate, business transactions, matrimonial, shareholder disputes, and other specialized engagements such as fiduciary breach cases.

Jason is a lead instructor for NACVA’s Forensic Accounting Academy and a speaker at Massachusetts Continuing Legal Education (MCLE) events and university courses. Jason is an active member of various professional organizations including the Business Valuation Committee of the Massachusetts Society of CPA’s. He has written and spoke on digital currencies for various organizations and at national conferences.