While many provisions of the Tax Cuts and Jobs Act have garnered significant publicity in the media (including the reductions in ordinary income tax rates for individuals), other provisions of the statute have flown under the radar. Many of these lesser-known provisions will have a direct impact on the divorce process; and, for spouses who are either contemplating a divorce or currently going through a divorce in Indiana, it will be important to understand how changes in the federal tax code may influence certain considerations and negotiation strategies involved in going through a divorce.
One of the most significant divorce-related impacts of the Tax Cuts and Jobs Act is the Act’s reversal of the income tax rules for spousal maintenance (or “alimony”). Under current law, a spouse who receives alimony is required to report all payments as taxable income, while the alimony payor is entitled to deduct these payments on his or her return. While this is less advantageous to alimony recipients in terms of tax liability, the ability to deduct payments provides a strong incentive for many high-earning spouses to negotiate alimony payments as part of the divorce process.
The Tax Cuts and Jobs Act’s spousal maintenance provisions are effective for divorces finalized on or after January 1, 2019. Under the Act, the federal income tax treatment for alimony is essentially reversed: recipients are no longer subject to income tax on alimony payments, and payors are no longer entitled to take alimony deductions.
The Tax Cuts and Jobs Act also implements new rules for personal exemptions and dependent tax credits. With regard to personal exemptions, the Tax Cuts and Jobs Act eliminates them entirely for tax years 2018 through 2025. Previously, divorcing parents had the opportunity to negotiate which would be entitled to take personal exemptions for their dependent children, which provided the potential for thousands of dollars in tax savings on an annual basis.
While doing away with personal exemptions, the Tax Cuts and Jobs Act increases the child tax credit for dependent children from $1,000 to $2,000, and it increases the refundable portion of the credit to $1,400. Although it would seem that this provides an additional opportunity for negotiation during a divorce, only the parent who is considered a child’s “custodial parent” is eligible to claim the credit. In order to qualify as a custodial parent, for tax purposes, a parent must live with his or her child for at least six months of the year.
In addition to eliminating personal exemptions for dependents, the Tax Cuts and Jobs Act also eliminates certain itemized deductions that are relevant to divorcing spouses. Accountant fees for tax advise related to a divorce are no longer deductible, nor are legal fees for advice related to spousal maintenance. Additionally, the itemized deduction for mortgage interest have been reduced: For mortgages incurred after December 15, 2017, only interest on amounts up to $750,000 can be deducted on a divorced spouse’s return.
If your divorce is pending at the end of the year, you are still considered married for federal tax purposes. This means that you have the option to choose either, “Married filing jointly” or “Married filing separately.” While filing jointly will offer additional tax savings opportunities for some couples, it also means that each spouse is responsible for the other’s errors and omissions (unless they are eligible for Innocent Spouse Relief). For individuals who have concerns about their spouses’ reporting of income and deductions, this is certainly a consideration to keep in mind.
After your divorce (and before you remarry), you have the option to file as, “Single” or “Head of Household.” While there are limits on former spouses’ ability to claim head of household status, this will often be a point of negotiation during the divorce process as well.
For business owners, the Tax Cuts and Jobs Act’s reduction in corporate and pass-through tax rates could also mean that more is at stake when it comes to dividing their “marital pot.” If the reduced tax rates result in higher business valuations as a result of improved cash flow (or owners of pass-through entities holding onto more reportable income), under Indiana law, this means that business owners will have more at stake in terms of distributable property in their divorce.
While college expenses can be included in child support payments under Indiana law, if spouses are unable to agree on an appropriate child support calculation, it is in the judge’s discretion whether to award support for tuition, room and board. In many cases, parents will find it advantageous to address college expenses outside of the confines of Indiana’s Child Support Guidelines, particularly when more flexibility or a more-creative solution is desired.
With parents now able to use 529 savings plans to cover up to $10,000 in annual pre-college private school tuition, 529 contributions may take on a more-prevalent role in divorce negotiations for some couples as well. With it generally being in both spouses’ best interests to mitigate their overall tax liability, it will be worthwhile for divorcing spouses to consider the best way to take advantage of this new rule.
Of course, these are by no means the only tax-related considerations involved in getting a divorce in Indiana. For legal advice tailored to your unique family and financial circumstances, we encourage you to schedule a confidential initial consultation.
If you live in the Carmel, IN area and would like more information about the tax implications of getting divorced, please contact our offices to schedule a confidential initial consultation with attorney Joshua R. Hains. You can reach us by phone at (317) 688-1305, or send us your contact information and we will be in touch with you shortly.