By Nicole Makris and Brian K. Zoeller
The family law practitioner should be aware of the significant impacts that the amendments to the Internal Revenue Code under the 2017 Tax Cuts and Jobs Act could have on their clients’ cases. While some changes (such as the updated income brackets and increased standard deductions) took effect on Jan. 1, 2018, the key changes affecting spousal maintenance will not take effect until Jan. 1, 2019. Depending on their circumstances, clients may wish to finalize their dissolutions of marriage prior to Jan. 1, 2019 to avoid the impending changes.
Repeal of the deduction for spousal maintenance
The Act repeals sections of the tax code affecting the treatment of alimony. Effective Jan. 1, 2019, payments for the support or maintenance of a spouse will no longer be deductible by the payor spouse, and the recipient spouse will no longer be required to claim the spousal support as income. These amendments apply to “divorce or separation instruments,” which are defined by the Internal Revenue Code as:
• A decree of divorce or separate maintenance or written instrument incident to such a decree;
• A written separation agreement, or;
• A decree (not already described above) requiring a spouse to make payments for the support or maintenance of the other spouse.
If the above provide for spousal maintenance, the Act affects them as follows:
• For decrees and agreements existing prior to Dec. 31, 2018, the payor spouse may continue to deduct spousal maintenance, and the payee spouse may still be taxed on the support.
• If the existing decree or agreement is modified after Dec. 31, 2018, the Act does not automatically apply to the modification. However, the amendments will apply “if the modification expressly provides that the amendments made by this section apply to such modification.”
• Beginning Jan. 1, 2019, the amendments apply. Modifications of decrees issued after Dec. 31, 2018 will also be subject to the changes.
When drafting agreements, it should be kept in mind that some provisions of the Act are scheduled to sunset in 2025 (e.g., the new tax brackets, standard deductions and the reduction of the dependency exemption) while others are not (such as the repeal affecting alimony). Therefore, it is imperative for clients who wish to continue to operate under the previous code as it pertains to spousal maintenance to finalize agreements in 2018. It is advisable to include safeguarding language that explicitly provides that the pre-amendments treatment of spousal maintenance applies.
Reduction of the dependency exemption, rise of the Child Tax Credit
Another change that is likely to affect settlement negotiations is the reduction of the child tax dependency exemption to zero. The definition of a qualifying child for the purposes of filing as head of household (which increased to an $18,000 deduction) and for the Child Tax Credit has not changed.
The Child and Family Tax Credit has increased from $1,000 to $2,000 for a qualifying child under the age of 17 at the end of the tax year. In order for a parent to claim this credit, the child must have lived with him or her for more than half of the tax year. This credit now phases out at an AGI of $200,000 for an individual and $400,000 if married filing jointly. A refund of up to $1,400 per child is included, even if the individual had no tax liability.
The elimination of the deductibility of spousal maintenance may have significant impacts on the amounts of spousal maintenance awarded by courts or agreed upon by parties. Without the incentive of a beneficial tax deduction for the payor, paired with the fact that the support will be received tax-free by the recipient (who may also be entitled to the refundable credit of up to $1,400), there could be a trend of decreased amounts of spousal support in 2019.
The ability to offer larger payments over time in the form of spousal maintenance when the parties are in vastly disparate tax brackets has been a valuable tool for family law practitioners that will vanish at the end of the year. It was useful in negotiations, as the party in the lower tax bracket often desired consistent income that could be offered by the spousal maintenance and the party in the higher bracket saw a tremendous tax write-off benefit. The loss of this incentive will make it more difficult to settle large assets/high income cases, but not impossible.
There could also be repercussions for existing antenuptial or postnuptial agreements that provide for spousal maintenance. The amendments could spark arguments that a pre-Act agreement is no longer equitable in light of the unanticipated changes affecting spousal maintenance. If spousal maintenance is a factor, it may be worthwhile for clients to revisit their agreements to determine if modification is appropriate.
The recent tax reform will likely bring noticeable changes to the landscape of settlement negotiations in family law matters and may have significant effects on the terms of future decrees and agreements between parties.
If clients are considering filing for dissolution of marriage, it is crucial to notify them of important timeline considerations if their goal is to have a dissolution decree issued by Dec. 31, 2018. However, the Act suggests that as long as an agreement is “entered into” prior to Dec. 31, 2018, the old rules may still apply regardless of whether a decree was issued on or before this date. A separation agreement entered into prior to the deadline may serve as a placeholder for the prior tax treatment if the parties’ intent is evident from their agreement.
There are considerations beyond the scope of this article, including changes that affect mortgage and home equity, § 529 plans and the estate and gift tax exemptions, that could also be relevant to your client’s case. It is important to advise clients to consult with their personal accountants in order to ensure they fully understand the potential tax consequences prior to finalizing an agreement.•
• Nicole Makris is a family law associate at Cohen & Malad, LLP. She can be reached at email@example.com. Brian K. Zoeller is a partner and family law practice chair at Cohen & Malad, LLP. Brian is a certified family law specialist as designated by the Indiana State Bar Association Family Law Certification Board. He can be reached at firstname.lastname@example.org. The opinions expressed are those of the authors.