How Does the New Tax Law Affect Divorce?

The 2017 Tax Cuts and Jobs Act (“TCJA”) made significant changes to the Federal Tax Code.  This act affects divorce settlements by eliminating the taxability of alimony payments and personal exemptions for children, while increasing the child tax credit to $2,000 for each child under 17.

Taxability of Alimony Payments

For decades, spouses who make alimony payments were able to deduct those payments from their federal taxes.  When this deduction was taken, the spouse receiving the payments was required to report them as income on their federal taxes.  This fundamental rule was reversed by the TCJA.  Effective January 1, 2019, alimony payments are neither deductible by the payor spouse, nor reported as income by the payee spouse. 

Essentially, the tax burden of alimony payments has shifted from the payee to the payor.  The difference here is that, in most cases, the payor spouse is in a higher tax bracket than the payee spouse.  Therefore, the money being transferred between the spouses is taxed at a higher rate.  In this way, the TCJA creates a tax savings for payee spouses and a larger tax burden for payor spouses.  To compensate, it is likely that alimony payments will be smaller in future agreements. 

New York State Taxes

To mitigate the effect of the TCJA on alimony payments, the New York State Legislature has maintained the rules of the prior tax law.  For purposes of state taxes, alimony payments are still deductible for payor spouses and taxable as income for payee spouses.

Agreements Signed Before 2019

If a divorce agreement was signed before 2019, nothing will change; these agreements are grandfathered in under the prior tax law.  However, if these agreements are updated after 2018 and the parties want it to be governed by the TCJA, they can stipulate that in the updated agreement.  If the agreement is updated and the new tax law is not referenced, in most cases, it will still be governed by the prior tax law.

Personal Exemptions for Children

Before the new tax law, a taxpayer with dependent children under 19 (or under 24 if full-time students) received an exemption of $4,050 per child.  An exemption, much like a deduction, decreases a taxpayer’s taxable income.  Under this rule, the taxpayer’s savings were dependent on their tax bracket.  For example, if they were in the 24% tax bracket, their tax savings would be $972 per child; if they were in the 32% tax bracket, their savings would be $1296 per child.  However, the TCJA eliminated this exemption in favor of increasing the child tax credit.

Child Tax Credit

Before the TCJA, a custodial parent received a $1,000 credit for every dependent child under 17.  A tax credit decreases a taxpayer’s taxes owed dollar for dollar.  This gives the taxpayer a flat savings, regardless of which tax bracket they’re in.  This credit was available to single taxpayers who earned between $2,500 and $75,000 per year ($140,000 for joint filers), at which point the credit would phase out (gradually decrease to $0).  The TCJA increased this credit to $2,000 and increased the “phase out income” for single taxpayers from $75,000 to $200,000 ($400,000 for joint filers).

These changes are good news for lower-income custodial parents.  Any custodial parent who is in the 24% tax bracket ($82,501 to $157,500) or lower will save more money under the TCJA than under the previous law.  For example:

Taxpayer A:  Single custodial parent of two children under 17, earning $50,000 per year (22% tax bracket).

Prior Tax Law:

($1,000 credit × 2 children) + ([22% of $4,050 personal exemption] × 2 children) = $3,782 Tax Savings

Current Tax Law:

$2,000 credit × 2 children = $4,000 Tax Savings

Conversely, higher-income custodial parents will see their tax savings reduced.  For example:

Taxpayer B:  Single custodial parent of two children under 17, earning $250,000 per year (35% tax bracket).

Prior Tax Law:

($1,000 credit × 2 children) + ([35% of $4,050 personal exemption] × 2 children) = $4,835 Tax Savings

Current Tax Law:

$2,000 credit × 2 children = $4,000 Tax Savings

In short, these two changes mean that parents who earn $157,500 per year or less will save more on their taxes for each child under 17 than they previously saved.  However, this does not account for the lost savings for children under 19 (or under 24 and full-time students) and over 16 that the personal exemption for children would have provided.  While this change won’t likely be a determining factor in divorce negotiations, it’s something to consider when discussing child support.

For a more personalized account of how the new tax laws will affect your divorce, contact Fass & Greenberg today to schedule a consultation. Our experienced matrimonial attorneys are prepared to help you have the most successful case possible.