What the new tax law elimination of the alimony tax deduction means for divorcing and divorced couples

Authored by Cynthia N. Grob, Esq.  and  Jarad Stiles, Esq., LL.M.

A provision of the new tax law that took effect January 1, 2018 will have a substantial impact on divorcing couples.

The new law eliminates the alimony tax deduction and will impact agreements and judgments entered into after December 31, 2018.  Until December 31, 2018 and for all agreements entered into or judgments entered before that date, the old law applies.

To understand the impact going forward we first need to understand how the old law worked.  Under the old law, if the payor spouse was a high earner, he or she was subject to a higher tax bracket (especially if filing single) while the payee spouse was usually in a lower tax bracket.  This has the effect of shifting income from the individual payor in a higher tax bracket to the payee in a lower tax bracket.  This tax shifting typically justified a higher amount of alimony because the payor spouse is able to take a tax deduction which was not limited to phase-outs based upon income, like some other deductions, as it was an above-the-line deduction.

The elimination of this deduction will likely have a chilling effect on the amount of future alimony obligations as payor spouses and courts tasked with determining alimony obligations may reduce alimony paid as the tax deduction related to those payments has been eliminated.  The new tax law will impact cash flow for both payors and payees and it will take the assistance of tax professionals and matrimonial lawyers to help divorcing couples negotiate agreements that maintain parity between the amount of alimony paid under the old tax law and the amount paid under the new tax law.

The elimination of the alimony tax deduction along with the expansion of various tax brackets and rates necessitates a complex calculation of the impact on cash flow for both payors and payees.

For instance the new tax law poses a double whammy for payors filing as individuals earning $157,000 to $191,650 as under the 2017 tax brackets and rates those individuals were taxed at 28% rate and under the new tax law their tax rate will raise to 32%.  That individual will also lose the deduction related to alimony paid thereby reducing their cash flow by both.

Other changes under the new tax law that impact divorcing couples relate to the dependency exemptions related to children of the marriage which are eliminated under the new law which should serve to eliminate arguments over the same.

However, under the new tax law, the Child Tax Credit (CTC) has significantly increased.  Under old tax law, the CTC was worth up to $1,000 per qualifying child, was refundable for taxpayers with earned income of at least $3,000, and phased out (decreased) for taxpayers with AGI above $75,000 ($110,000 for joint filers). These rules remain in effect for 2017 tax returns (filed in 2018).  Under the new tax law the CTC is worth up to $2,000 per qualifying child. The age cut-off remains at 17 (the child must be under 17 at the end of the year for taxpayers to claim the credit).  Under the new law the beginning credit phase out for taxpayers does not occur until their AGI is above $200,000 ($400,000 for joint filers).

There are a few considerations that flow with the new CTC:

• The refundable portion of the credit is limited to $1,400. This amount will be adjusted for inflation after 2018.
• The earned income threshold for the refundable credit is lowered to $2,500.
• The child must have a valid SSN to claim the nonrefundable and refundable credit.

Under the old law, the taxpayer who was eligible to claim the child’s dependent exemption was also the one eligible to claim the CTC. In turn, the taxpayer and child had to meet several “tests” for the one to be considered the dependent of the other.  The new eliminates the dependent exemption itself, but retains the definition of dependent to claim the CTC and other child- or dependent-related tax benefits.

For CTC purposes, this will usually mean that the child must be related to the taxpayer in one of several ways (son, daughter, grandchild, etc.), must live in the taxpayer’s home more than half the year, and must not provide more than half of his or her own support.

Generally, the custodial parent is the parent with whom the child lived for the longer period of time during the year.  However, the child will be treated as the qualifying child of the noncustodial parent if the special rule for children of divorced or separated parents (or parents who live apart) applies. See Publication 504, Divorced or Separated Individuals, for more information. This rule requires in part, that both of the following conditions are met:

• The custodial parent signs a Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a substantially similar statement, and
• The noncustodial parent attaches the Form 8332 or the statement to his or her return.

If the custodial parent releases a claim to exemption for a child, the noncustodial parent may claim the child as a qualifying child for the child tax credit. However, generally, the noncustodial parent may not claim head of household filing status or the earned income credit, and the noncustodial parent may not claim the credit for child and dependent care expenses, the exclusion for dependent care benefits, or the health coverage tax credit.

The elimination of the dependency exemption and the increase in the amount of the CTC as well as the amount of income a parent can earn before the CTC phase out begins from $75,000 to $200,000 will likely change the discussion for divorcing or separated individuals regarding these credits.  Again, they will likely require the assistance of both matrimonial attorneys and tax attorneys and professionals to calculate the impact on their cash flow that will result from the new tax laws.

Every tax payer’s situation is different. Depending on a myriad of factors certain tax payers may be subject to phase outs and the alternative minimum tax. Please see your tax professional for your specific situation.

For more information, see our tax legislation overview here.

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