If your marriage is on the rocks, you need to be thoughtful about the timing of decisions -- the government has recently enacted many tax laws that impact divorcing couples, especially those with high net worth.
Tax codes are confusing in the best of times.
This – let’s be honest – is not the best of times, which makes it more important that you understand how these new laws affect you.
How do you decide if it is in your best interest to settle this year?
First, take a deep breath. Second, consider these four items below and what impact they will have on you.
Third, work with an attorney as well as a financial advisor experienced in divorce to minimize the pain from the new laws.
1. Move Fast To Control Taxes On Alimony
Alimony, often called spousal support or maintenance, will have a significant change on New Years’ Day in 2019.
Under current laws, this has been deductible by the paying spouse and taxable to the receiving spouse.
This benefited the family unit as the recipient paid tax at a lower rate than the payor deducted it at resulting in less in taxes.
The deduction can save up to almost 50% in taxes for top earners in high-tax states so for every $100,000 alimony paid it only costs $50,000 after-tax.
The recipient on the other had may only have to pay $20,000 in taxes on that $100,000 received resulting in $80,000 of after-tax income.
The net savings to the family is the $30,000 difference. This “divorce subsidy” is a nightmare for the IRS to track and costs the government money.
Going forward, alimony will not be deductible by the payor or taxable to the recipient. Initially you might think that the receiving spouse would be happy about this, but there are a few key reasons that it hurts divorcing individuals:
The change is permanent and will likely result in less alimony being paid to the receiving spouse. It’s estimated the elimination of this “divorce subsidy” will raise an additional $6.9 billion over the next decade for the government – meaning $6.9 billion less in divorced individuals’ pockets.
It may result in non-working divorced spouses no longer being eligible to make IRA/Roth IRA contributions.
Why finalize in 2018? If you finalize in 2018, alimony will remain deductible by the payor and taxable to the recipient for the duration of your agreement.
Even if you modify your agreement in the future, you'd still retain the deductibility/taxable status unless the modification expressly provides that the new law applies going forward.
This is strong motivation for those who are in the process to finalize their divorce before the ball drops on 2018.
2. Tax Benefits Of The Family Home Are Changing
Home. This is a hot-button item in many divorce situations. Is it a top priority to keep it? Are you eager to leave it behind with the past? How do you split the value? You must focus on your home as a financial asset while factoring in the memories as well as the potential emotional and community stability it may provide.
The new law reduced the deductibility of property taxes and the amount of mortgage that qualifies for interest deduction making it more expensive to own a home under the new tax laws. In addition, total selling costs typically range from 7-10% and you can realize up to $500,000 in gain without tax consequences while married but only $250,000 of gain with no tax due if you sell when single. These facts combined make it critical to analyze whether to sell the marital home before the divorce is final. Downsizing or renting is often a difficult, but smart choice.
3. Kids Are No Longer As Great As Of A Tax Deduction
The new tax code eliminates the personal exemption amount for tax years 2018 – 2025, which means that you don't get a multiplier of kids as a deduction on your tax return.
It's still important to negotiate who will claim the kids though.
While the exemption amount is $0, it may qualify the parent for additional child tax credits which are more generous under the new law.
If you have young kids, you may see an increased benefit in the future since the exemption is scheduled to go back to $4,000+ per person in 2026.
4. Pre- And Post-Nuptial Agreements May Be In Jeopardy
Couples with Pre-nuptial or Post-nuptial agreements should have their agreements reviewed this year to assess the impact of the law.
It is possible that these new tax laws may make some of the items you’ve both already agreed to moot.
Any alimony provisions likely assumed it would be deductible and there may be significant unintended consequences with the change in 2019. Be certain to have your attorney compare your agreement to the new laws and be prepared to re-negotiate if necessary.
Balancing the family dynamics during a divorce to create a healthy restructuring of the family is never easy.
The new laws have added an additional layer of complexity and urgency. While it is extremely important you do not feel pressured to settle, it is equally important you educate yourself on laws and tax codes which may have a lasting impact on your future financial health.