If your marriage is on the rocks, maybe 2018 is the year to call it quits—for tax reasons. Wait, what? Anyone who has been through a dissolution of a marriage knows divorce isn’t cheap. For some, it’s going to get even less affordable.
While most couples do not enter marriage planning to get a divorce, the reality is that divorce occurs in about 41% of all first marriages and about 60% of all second marriages, according to the U.S. Census Bureau. Because divorce is often an emotionally charged time, both parties must be very careful when planning for the financial well-being of each party as well as any children involved. This, of course, brings us to the changes afoot.
The Tax Cuts and Jobs Act changed the federal tax treatment of alimony payments. For any divorce or separation instruments occurring after Dec. 31, 2018, alimony will no longer be deductible from the paying spouse’s taxes, and likewise, the spouse getting support will no longer owe income taxes on the money received. However, the new rule won’t affect anyone who’s started paying alimony by Dec. 31, 2018 – they’re grandfathered in. And, just in case you’re wondering, the typical time it takes to complete a divorce is 10.7 months, according to Nolo.com.
Under the current rules, alimony payments are deductible as an “above-the-line” deduction while alimony received is included in gross income for the recipient. This deduction made alimony more affordable for the paying spouse, and often shifted the money to someone in a lower tax bracket.
Let’s say Tom and Lisa are getting divorced. Tom has a taxable income of $210,000 and Lisa does not work. Their divorce agreement states that Tom will pay alimony to Lisa of $48,000 per year. If the divorce is settled before Dec. 31, 2018, Tom will pay tax on $150,000 of income ($210,000 less $48,000 alimony and $12,000 standard deduction) at his 24% tax bracket. His tax bill would be $30,289.50. Lisa would pay tax on $36,000 ($48,000 less her standard deduction of $12,000) at her marginal rate of 12%. Her tax bill would be $4,129.50.
If the divorce is executed after Dec. 31, 2018 the new rules will apply to them. Tom will not be able to deduct the $48,000 in alimony payments. This will push Tom in to the 32% tax bracket; therefore, his tax bill will be $45,049.50. On the other hand, Lisa will not have to pay taxes on the $48,000 she receives.
This begs the question, should Lisa receive less now that her “income” is tax free? If so, how much less? $4,129.50 less, since that was her tax liability, or $14,760 less since that is what it will cost Tom? Should Tom and Lisa reconsider marriage counseling?
With so many tax changes ahead, it is critical that divorcing couples not only work with a lawyer and an accountant, but a financial expert like a Certified Divorce Financial Analyst® who can help project how financial decisions today will affect an ex-spouse’s financial future. Without alimony included in gross income of the recipient, this may affect their ability to make an IRA contribution. The elimination of personal exemptions for dependents and the increase in the child tax credit will also affect a divorcing couples’ tax situation.
Further complicating divorce proceedings is that most of the tax law changes are set to expire after Dec. 31, 2025. While no one can predict future tax laws, you may want to consider including a tax clause just in case the law reverts to 2017 rules.
If you have questions regarding the financial aspects of your divorce, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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