The most significant tax reform in thirty years was signed into law December 22. With barely a week to understand how it impacts all open and future divorce cases, it became effective January 1, 2018, unless otherwise noted. Many of the provisions have sunset dates, upon which rules will revert to pre-2018, unless extended.
Alimony, beginning January 1, 2019, will not be tax deductible for payer, nor taxable to the recipient. Modified orders, after that same effective date, will adhere to the previous tax deductible/taxable treatment in the original orders, unless it is specified in the modification orders that the new not deductible/not taxable treatment will apply. Although the effectiveness of this dramatic change has been delayed for a full year, we will need to pay attention to it immediately for any active cases that are not expected to conclude before December 31, 2018.
Tax Brackets have been adjusted more than normal annual inflation adjustments. Some for the better, others not so much. Most Tax Rates have changed a few percentage points: 10% remains same, 15% to 12%, 25% to 22%, 28% to 24%, 33% to 32%, 35% remains same, 39.6% to 37%. As always, we will need to continue to reference a client’s new tax bracket and rate according to their future filing status, Single or Head of Household (HOH), rendering previous Married File Joint bracket, rate and withholding meaningless. This rate structure sunsets at year end 2025.
The Standard Deduction, taken in lieu of itemized deductions, will increase from $6,350 to $12,000 for a Single filer, and from $$9,350 to $18,000 for HOH. (Additional for over age 65.) This is significant when taken in full context with all the itemized deductions that have been eliminated. Depending on the circumstances, it could also make the HOH filing status more valuable. Increased standard deduction sunsets after 2025.
Personal Exemption suspended. This is the $4,050 reduction in taxable income for each child, claimed as a dependent, that clients find so desirable. Although this exemption phased out for Single and HOH filers with income above $261,500 and $287,650, respectively, they still tried to convince us it was “worth more” to them in the higher tax brackets. Focus will now need to shift to other child-related tax issues in negotiating which parent claims the child(ren) for greater overall tax advantages. However, this suspension sunsets at year end 2025.
Child Tax Credit increases until year end 2025. Up from $1,000, $2,000 credit per qualifying dependent child, under age 17, available to Single filers and HOH with Adjusted Gross Income (AGI) less than $200,000, with phaseout thereafter. Credit is refundable (payable if tax liability is less than credit) to a limit of $1,400 per child.
The Primary Residential Parent can still file as HOH, claim the Child Care Expense Credit up to $5,000, Dependent Care Exclusion up to $5,000, and Earned Income Credit up to $6,444, qualifications apply.
Other Child Tax Issues The American Opportunity (formerly Hope) credit, up to $2,500 per eligible student per year for parent with modified AGI under $80,000 (other conditions apply) remains unchanged. Lifetime Learning credit, up to $2,000 per taxpayer having modified AGI under $56,000, for dependent students (other conditions apply) remains unchanged. Both available to parent who claims child as dependent.
Funds in 529 plans may now be used for qualified primary and/or secondary school expenses, limitations apply. No new contributions may be made to Coverdell accounts. Coverdell funds may be rolled to 529s to extend their use through college.
College Student Aid qualifications will potentially be more sensitive to the shift in taxable income because of the alimony change and other terms of the Parenting Plan.
Mortgage Interest deduction has new limitations, whereby only interest on acquisition indebtedness (reduced from $1M to $750k) will be deductible, thereby suspending the deduction of interest on subsequently incurred HELOC debt. The suspension expires after 2025.
Divorce Legal Expenses deduction for those identifiable as directly related to procurement of alimony is eliminated since alimony is no longer taxable income to recipient.
Overall, this tax reform was extensive and many other elements of it may impact individual divorce situations, depending upon the circumstances. This serves as an overview of those changes likely to affect most clients. Also, questions have already emerged which will require further clarifications as the new tax rules are implemented.