How the New Tax Law Changes the Economics of Divorce
The tax overhaul of 2018 has significant changes for all Americans, and particular impact on divorcing couples.
Alimony Payments No Longer Deductible
Alimony payments specified in separation agreements and court ordered alimony payments dated after December 31, 2018 will no longer be deductible to the payor and taxable to the payee. This will dramatically affect the economics of divorce. Although the recipient spouse will no longer have to report the alimony as income (and thus will not pay tax on that alimony), neither will the payor spouse have the benefit of a tax deduction for the alimony payments. Thus, the payor spouse can be expected to push for lower alimony payments because the lack of a deduction makes the payouts more expensive. It’s important for separating and divorcing people to evaluate their options sufficiently in advance of December 31, 2018 to maximize dollars available to lower payments.
The elimination of this deduction will also impact alimony buyouts; that is, where instead of paying alimony in monthly installments over a period of time, the parties negotiate the payment of a one-time lump sum. Those settlements have historically incentivized agreements for lower lump sum amounts – the money is received sooner, a bird in the hand, etc. But with no alimony deduction, the ability to negotiate a lower lump sum payment will be lessened.
How the Dependency Exemption and Child Tax Credit Now Impact Negotiations
A second significant impact on divorcing couples relates to the historical relationship between the dependency exemption and the child tax credit. Under the old law, parents could negotiate which of them could claim the dependency exemption on their individual returns after divorce. This valuable tool provided flexibility and value in negotiations. Moreover, the child tax credit historically was tied to that exemption; that is, the parent with the dependency exemption was also entitled to the child tax credit. Under the reforms, the dependency exemption has been eliminated.
Additional Tax Reforms Affecting Divorcing Couples
Other reforms impact divorcing couples as well, particularly in connection with negotiating settlements. Interest on home equity lines of credit (HELOCS) is no longer deductible. HELOCS have historically been a source from which other obligations are funded, such as payment of debts or taxes, or funding of college education. Another: Child support is, in most cases, determined by the application of a legislative formula based on assumptions including the deductibility of alimony and the existence of a dependency exemption. With the invalidity of those underlying assumptions, what effect, if any, will there be on child support in Maryland?
These and other issues present uncharted territory. People negotiating settlements or preparing a case for trial will need to carefully consider these changes with their divorce attorney.
Deborah Reiser is a divorce attorney who practices in Maryland and the District of Columbia. For more on how the new tax laws impact divorced couples, contact her at 301-961-6094 or [email protected].