As forensic accountants, we provide assistance to attorneys regarding financial issues in divorce proceedings, including alimony, standard of living, distribution of the marital estate, business and pension valuations, and tracing and allocation of non-marital asset claims. Many of these financial elements in divorce proceedings have been impacted by the Tax Cuts and Jobs Act H.R.1. passed by Congress last December.
In our recent article published in Family Lawyer Magazine, we discuss some of these implications – namely that H.R.1. has effectively reversed the tax burden of alimony. The deductibility and taxability of alimony is an important consideration in most cases. Under the new tax law, alimony payments will not be tax deductible for the payor spouse, and alimony will no longer be considered gross income for the recipient in divorces and legal separations executed on or after January 1, 2019.
But, the deductibility of alimony is not the only new tax implication that family law professionals should be aware of in providing counsel to their clients.
Tax brackets for individuals will decrease to from 10 to 37%. The impact on any taxpayer will depend on many factors. The standard deduction increases to $24,000 for married filing joint and $12,000 for single. The repeal of personal and dependency exemptions; dollar limit on itemized deductions for state and local taxes; and changes to the child tax credit (increase to $2,000/qualified child, with $1,400 being refundable) will affect tax computations.
The itemized deduction for interest on new principal residence and second residence mortgages up to a combined $1,000,000 is reduced to $750,000. And, interest on a HELOC is no longer deductible. However, the Act did not change any rules on the sale of a principal residence.
Why does this matter? Alimony is often calculated based on a formula that considers taxable income, available assets and, in the past, the deductibility benefits for each party. Lower tax rates mean that even if alimony is taxable/deductible the benefit will not be as high for the payor. This will likely have implications for both new divorce decrees and modifications made to existing decrees after the January 1 effective date.
Additionally, computer programs used to calculate alimony and child support will need to be revised to consider the changed rates, deductions and other provisions. Prior to receipt of modified programs, manual adjustment will be needed to avoid incorrect calculations.
Legal and accounting fees that were deductible as itemized deductions are no longer allowed. All miscellaneous itemized deductions subject to the 2% floor under the current law are repealed through 2025. Legal fees that were deductible for procuring alimony are no longer deductible because of this provision.
For divorce cases where business ownership is a consideration, changes to the corporate tax law are also highly relevant factors. In 2018, the Act makes the corporate tax rate a flat 21% and eliminates the corporate alternative minimum tax. Further, some S Corporation and Partnership owners will receive a 20% deduction for certain pass through income. The implication is that business valuations are likely to increase as the new corporate and flow through rates for pass through entities provide increased cash flow for valuation purposes.
Looking ahead to the 2019 deadline, the new tax law will make it desirable to bring cases in which alimony deductibility is important to conclusion prior to the year end.