Effects of the House’s “Tax Cut and Jobs Act” on my Divorce and Divorce Agreement
On November 16, 2017, the House passed its “Tax Cut and Jobs Act,” setting the stage for the biggest tax reform legislation in decades. For more details on the bill, feel free to peruse the analysis performed by your news-provider-of-choice. While passage by the House does not guarantee anything as of yet (the Senate is still working on their own tax reform bill), tax reform certainly appears likely by the end of the year.
Any tax reform legislation passed this year is going to affect nearly every household in America. It is also going to present numerous changes to how couples negotiate their divorce settlement agreements. The following are some of the key changes proposed in the “Tax Cut and Jobs Act” and how it might affect your divorce:
1. Repeal of Alimony Deduction:
Ever since the Revenue Tax Act of 1942, alimony (also referred to as spousal support or maintenance in certain jurisdictions) has been treated as taxable income to the recipient and tax deductible to the payor. The Tax Cut and Jobs Act would eliminate tax deductions related to alimony.
First, it is important to note that, as proposed, this would only affect alimony payments pursuant to a divorce agreement or court order entered after 2017. If you are already paying or receiving alimony, this change will not affect you (yet). If a current alimony award is modified on or after January 1, 2018, it is assumed that the new alimony payments would not be taxable/tax-deductible.
At first glance, this appears to favor the recipients of alimony. They don’t have to pay taxes on the money they receive and the higher earning spouse would no longer get a big tax deduction. However, due to the payor spouse being in a higher income tax bracket than the recipient spouse, this will cost the “couple” more in combined taxes. I foresee this leading to more difficult negotiations as there is less money to spread between the parties and less “incentive” to offer a higher amount of alimony. Again, this is all speculative, but I am interested to see how this plays out.
For anyone with a “modifiable” support award, there may also be a lot of incentive for a recipient spouse to take advantage of the changes to the tax code and seek a modification in 2018.
Even before the bill officially passes, I will certainly consider its potential effects while negotiating and drafting divorce settlement agreements.
2. Reduction to the Mortgage Interest Deduction:
Currently, homeowners may deduct any interest paid on their mortgage, up to the first $1 Million. The Tax Cut and Jobs Act proposes to reduce that cap to $500K. In areas with high property values, such as Northern Virginia and Washington, DC, mortgages over $500K are commonplace. This would reduce the benefits one receives while paying towards a mortgage.
Once again, in its current form, this will only apply to purchases on or after January 1, 2018. However, no mention has been made to whether or not this will affect refinancing of a current mortgage.
In many divorce settlement negotiations, one of the most important issues couples face is what to do with a marital home. Typically, it comes down to one of two outcomes: 1) a house will be sold, or 2) one party will “buy out” the other of his or her share of the equity in the property. The change in the tax code may have a significant impact on that decision. The new mortgage, without the benefit of the full mortgage interest deduction, may be cost-prohibitive. This may affect a person’s ability to stay in the home or afford a new comparable home. It could make it harder for a parent to keep a home in the children’s same school district.
During settlement negotiations, it is even more important to fully understand the possible effects of this legislation. I often refer many of my clients to work hand in hand with a mortgage specialist, so they can make a more informed decision about their future living arrangements.
3. Capital Gains Exclusions Modified:
Currently, a seller of a home is entitled to shelter capital gains from the sale (up to $250,000 for an individual and $500,000 for a married couple filing jointly) so long as they primarily reside in the home during at least 2 of the previous 5 years. The new legislation proposes to increase this threshold to at least 5 of the previous 8 years.
If one spouse decides to keep the home after a divorce, they are already lowering the exclusion from $500,000 to $250,000 after the divorce. This may have a significant tax impact on the party keeping the home if the property appreciated by over $250,000 during the period of ownership. Now, a spouse looking to keep the home must also consider how long they intend to stay in the home.
Let’s look at the following example: Amy and Bob buy a house in 2018. They separate in 2020. Amy decides she would like to keep the house until their son, Charlie, goes to college in 2022. If her plan is to sell the house after Charlie goes to college (2022) she will only have owned and lived in the house for a period of 4 years and would not be eligible for the exclusion. This means that any gains in the property will be taxable in the year of the sale.
Once again, family law attorneys will have to discuss this scenario with their clients when deciding to keep the marital home. It is also important to have a client work closely with a trusted tax advisor during this process.
4. Increased Child Tax Credit:
The new bill seeks to increase the child tax credit from $1,000 per child to $1,600 per child. Additionally, income phase outs will increase from $75,000 to $115,000, meaning that you can earn more money before you start losing the benefit of the tax credit. These changes will help families on their year-end tax bill, so long as they are paying taxes. However, in a divorce, only one party can claim a child each year. However slight it may be, this may impact the financial effect of dividing dependency exemptions in a divorce.
Remember, the Tax Cut and Jobs Act only passed the House to date and is not yet law. This article is being written only to make readers aware of the potential effects of such a law. I intend to continue monitoring the progress made in both branches of Congress. The ultimate outcome of this legislation will clearly have a tremendous impact on all Americans and the financial issues discussed during divorce settlement negotiations.