10 Questions by Attorney Debbie Smith of Watertown Massachusetts regarding divorce issues and paternity cases for David Goodman, CPA in light of the new federal tax law
The new tax law that was signed by the President on December 22, 2017, is anticipated to cause family law lawyers and their clients to seek changes to the way they have been working on divorce and paternity cases. To find out how to best to save people money going through divorce or pursing a paternity matter, Attorney Smith has drafted some questions for David H. Goodman, CPA/ABV/CFF, CVA to provide answers (which he has answered in blue below) in light of the new tax law.
Many clients have sought dependency exemptions, deductions for alimony and other ways to save money before the new tax law was signed. However, times have changed and new ways to resolve divorce and paternity cases will have to be sought.
1. Are the dependency exemptions for parents still available for the federal tax returns in 2017 and 2018?
The personal exemptions beginning with tax year 2018 are suspended between 2018 and 2025. They are reinstated in 2026. The exemption previously was $4,000 reduction in income per exemption. An example of the tax savings for someone with a 25% marginal tax rate, meant a reduction in tax of $1,000.
2. If there are no dependency exemptions in 2018, are there any other tax savings that a parent could seek on their federal income tax return instead? Also, what is a child tax credit and how much savings could a parent receive?
There is a child tax credit for parents who have children under the age of 17. Not only is the child tax credit still available for qualifying children under the age of 17, two aspects of it have been increased. First the credit itself is increased for tax years beginning 2018 from $1,000 to $2,000 per child. For a single parent the threshold income has increased from $75,000 to $200,000 to claim this child tax credit. These changes also revert back to the old law in 2026. However, if you remember from your previous question, the loss of the exemption for a child equates to a $1,000 increase in taxes for many taxpayers depending on their tax rate. The increase in the child credit may offset this increase for some parents.
3. Could a payor still get a tax deduction on the federal income tax return for payment of alimony for 2017, if it is in a Separation Agreement that has been allowed by the court in 2017?
The new tax act makes alimony not deductible by the payer and not taxable to the recipient for separation agreements for a divorce case entered into after December 31, 2018. This appears not to apply to modifications of existing agreements made after December, 31, 2018, unless the modification specifically states it will apply. Accordingly, if alimony is deductible to the payer and taxable to the recipient, for separation agreements in divorce cases entered into before January 1, 2019, they are still deductible.
4. What about if the Separation Agreement is signed in 2018, could the alimony still be deductible by the one paying the money to the spouse receiving the money in 2018?
Yes. Since the agreement is entered into by December 31, 2018, alimony would be deductible to the payer and taxable to the recipient provided the other rules for alimony are met. In other words, if the parties in a divorce come to an agreement and put it in writing in a Separation Agreement by the end of the year in 2018, alimony is still deductible to the one paying the alimony and taxable to the one receiving the alimony as long as the agreement doesn’t say otherwise.
5. If the divorce is not completed by the end of 2018 and the parties are working out an alimony as part of support in the Separation Agreement, what can be done if the one paying the alimony can’t deduct it from their taxes in 2019 and in the future?
Alimony payable under a divorce or separation agreement must be signed and allowed by the court by December 31, 2018, if the parties wish the alimony to be deductible by the payer and taxable to the recipient. In the situation where the husband is by informal agreement paying bills on behalf of the wife, there is little motivation for the wife to settle before the end of the year. However, it may save the family money in the long run by coming to an agreement by the end of this year. If one is thinking about filing for a divorce, it is better to participate in mediation, collaborative law or other alternative dispute resolution process to look at all options available now, get an agreement signed and allowed by the court by the end of 2018.
6. Doesn’t it save money for the person that receives alimony in 2019 and thereafter as they don’t have to include it as part of income on their federal income tax return? Please explain why.
Yes, the person that receives the alimony benefits by receiving nontaxable support. Alimony in an Separation agreement in 2018 is deductible by the payer, then it is also taxable to the recipient. (Alimony paid or received is included in a person’s adjusted gross income on the front page of the federal income tax return.) This may impact the amount of certain deductions or whether the person qualifies for certain tax credits. Alimony income is taxed at ordinary tax rates. So if alimony is not taxable, then it is similar to child support beginning in 2019 as neither are deductible on ones taxes. Most likely, the payer will seek to compute alimony based on a lower percent. For example, consider a payer earning $100,000 and deductible alimony was computed at 33% of gross income. For the payer to end up in the same place after-tax, alimony would have to be computed at about 22.5%.
7. What are the recapture rules regarding federal income taxes and will they apply after 2018? Who will it apply to?
After 2018, since alimony is not deductible, the recapture rules don’t apply. Neither do the concerns about alimony being considered deemed child support. The good news is this provides a lot of room for creatively structuring support payments. Alimony may be front loaded (paid up front) or reduced with contingencies related to a child, such as if the child graduates from high school or college.
8. Are dependency exemptions and alimony deductions still allowed on the Massachusetts state income tax returns in or after 2018 or 2019?
Massachusetts has not indicated to what extent it will conform to the Federal changes. Massachusetts taxes don’t follow the Federal Tax Code (as of 2005) with the exception of certain items. The following in the Massachusetts Tax Code automatically conform to the current Federal Tax Code (i) Roth IRAs, (ii) IRAs, (iii) the exclusion for gain on the sale of a principal residence of $250,000 per owner, (iv) trade or business expenses, (v) travel expenses, (vi) meals and entertainment expenses, (vii) the maximum deferral amount of government employees’ deferred compensation plans, (viii) the deduction for health insurance costs of self-employed taxpayers, (ix) medical and dental expenses, (x) annuities, (xi) health savings accounts, (xii) employer-provided health insurance coverage, and (xiii) amounts received by an employee under a health and accident plan. Not included on this list is alimony. We do not yet know whether alimony paid will continue to be deductible by the payer and taxable to the recipient on the Massachusetts individual income tax return.
I expect the dependency deductions in Massachusetts to stay in place.
9. Can the two parties seeking a divorce still claim the property taxes and state income taxes for their marital home on their federal income tax returns for 2018?
Under the new tax law, beginning in 2018, the maximum deduction for state and local taxes is $10,000 ($5,000 for married filing separately). It does not matter whether the tax is a property tax or income tax. This creates a hidden marriage tax. Single persons also may deduct up to $10,000 in state and local states.
To offset this, the standard deduction has been increased. It is now $24,000 for married filing jointly, $18,000 for head of household, and $12,000 for everyone else. However, this increase in the standard deduction changes and reverts in 2026 back to the amounts in place before the new tax law.
10. Since homes in Massachusetts have gone up in value so much recently, does the $250,000 credit per person still apply if two people sell their marital home so they don’t have to pay capital gains taxes on that money if their house sells for a lot more then they paid for it.
There is no change to the exclusion on the sale of the primary residence. However, there is a change to what interest can be deducted. Starting in 2018, the deduction for interest expense on a residence is limited. For loans entered into after December 15, 2017, the allowable maximum debt is $750,000 – down from $1,000,000 and home equity interest is no longer deductible. Previously the interest on up to $100,000 in home equity debt could be deducted. This means parties looking to finance property settlements with debt will have to refinance their mortgage, rather than take a home equity line.
Thank you David for your thoughts on this changing tax climate.
This article is not meant to provide legal advice by Attorney Debra L. Smith or tax advice by David H Goodman, CPA. It is meant for informational purposes only. Both Attorney Smith and Mr. Goodman state that one should seek legal and accounting advice on their specific case.
2018 Copyright Debra L. Smith and David H. Goodman, CPA. All rights reserved.