Time to Split? Your Divorce Under the New 2019 Tax Cuts and Jobs Act
Divorce is good for some and devastating for others, but both sides can agree on one thing: It is expensive.
What is the Tax Cuts and Jobs Act?
The bill, which was originally signed into law in December 2017, was designed to simplify the tax code. The change was sold based on the idea that the decrease in itemizations would save much more money in the IRS payroll than in the increase would cost.
More importantly, simplifying the code would reduce the economic expense of over 6 billion hours that Americans need to jump through the hoops of the old code by collecting receipts and itemizing their deductions.
Also, the law changes several big-ticket itemized deductions, including the expansion of the child credit. The child credit is increasing from $1000 to $2000 per child for those making up to $400k—raised from the previous cap of $110k. The act also introduces major changes to the way spousal support is taxed.
No Spousal Support Deduction Starting January 2019
Although spousal support has been historically a tricky area of law to understand. With every state having a different set of regulations on how, when, and to whom it is paid, one thing has been consistent: the payer can deduct the support from their income before taxes and the recipient pays taxes as if it were income.
Starting Jan. 1, 2019, that will no longer be the case.
The Tax Cuts and Jobs Act completely turns this idea upside down, making spousal support payment taxes the responsibility of the payer instead of the recipient, since the new law states that these payments are not eligible to be counted as a deduction. That means that any spousal support paid on divorces in 2019 will be included in the payer’s taxable income and excluded from the recipient’s.
For recipients, this seems like a fantastic windfall on the surface. Since spousal support payers often have a higher income than recipients, the new law means that the tax burden falls on the spouse more financially capable of handling it. Unfortunately, the old system meant that the taxes on spousal support was paid by the lower-earning spouse, putting them in a much lower tax bracket and decreased the overall payment.
Couples with very different incomes will be hit hardest by this law, as it will be a major change for spousal support negotiations.
2019 Tax Cuts and Jobs Act in Action
Although the law looks good for recipients of spousal support on the surface, there are arguments that the law may do more harm than good.
For example, if a man getting a divorce makes $500k per year and pays $100k in spousal support, he currently only pays $60k per year after the deduction. His ex-wife pays $15k in taxes on that money since she is in a lower tax bracket, leaving her $85k to live on.
Under the new law, that same man will end up paying the full $100k in support, also, to double the amount in taxes paid—about $30k, for a total burden of $130k in support costs—since he is in a higher tax bracket.
While not having any tax burden on the spousal incomes may seem advantageous to the ex-wife, it represents a giant loss in the long run. Women make up between 90-97% of spousal payment recipients.
The extra $15,000 in our example for taxes paid to the government has to come from somewhere. Not having the tax break as an incentive may mean lower spousal support settlements in the long-term, minimizing the already razor-thin incomes that many women have post-divorce.
The potential for a “chilling” effect on divorces is real, as some women simply will not have the bargaining power of the tax benefit to negotiate a livable spousal support settlement. This may mean an increase of messy divorces, with many unable to settle out of court.
For some, the emotional pain, embarrassment, and cost of a divorce will be too great and may lead to more women staying unhappily in marriages merely for financial reasons.
Navigating Divorce in the Choppy Legal Waters of 2019
Those with Current Divorce or Separation Agreements
If you’re concerned that the new rules make affect your current divorce documents, you don’t have to worry. Any completed divorces before the beginning of the year are not susceptible to the changes in the Tax Cuts and Jobs Act.
As long as you are meeting Ohio and federal legal requirements and payment schedules, you will be able to write off your payments without itemization just as you always have.
For your payment to qualify as tax-deductible, you must meet the following requirements:
- Written Instrument Requirement. You must have a written document proving your divorce or separation. This can be a divorce decree, separate maintenance decree, or separation instruments.
- Payments Made to Spouse. Only payments under divorce or separation documents are eligible. This includes payments made to third parties like attorneys or financial officers that are handling your finances.
- Earmarked for Spousal Support. Payments must be specified as part of spousal support, otherwise, they can be considered “gross income.”
- No Cohabitation or Joint Filing. Once your divorce or separation is completed, living together or filing taxes together is a no-go, especially if you want to deduct your spousal support payments.
- Cash or Cash Equivalent Only. Payments must be made in cash or an equivalent such as a check or money order.
- Spousal Support Payments are NOT Child Support. Child support payments are completely separate for spousal support. Make sure that your spousal support payments are completely separate from child support (separate accounts, separate payment dates, etc.) to protect yourself from this often misunderstood tax hole.
- Include the Recipient’s Social Security Number. Even though communication in divorce is hard, it is vital to get this piece of information from your ex-spouse, otherwise, you will not be able to deduct your payment.
- Relief of Obligation Post-Mortem. For a payment to be deductible, your separation or divorce documents must identify payments end if the recipient dies. If you live in a state where payments must continue after the recipient dies (to the estate or other beneficiaries), your payment cannot be deductible. This rule is the biggest roadblock for deducting spousal support payments.
Those Planning for a Divorce or Separation in 2019
If this is the year that you’re planning to finalize your separation or divorce documents, please be aware that these changes will affect you directly. Whether you’re initiating the divorce or end up being the main provider of spousal support, the Tax Cuts and Jobs Act will play a part in your negotiations and settlement.
If the new tax changes are giving you heart palpitations, you’re not alone. Many spouses who are in the highest income brackets are working with family lawyers to come up with financial solutions that will help mitigate or work around the new legislation.
Talk with your lawyer about options such as:
- Reorganizing settlements to focus more on cash, business holdings, or property. If a settlement focuses more on dividing shared assets, the amount needed in spousal support will decrease.
- Developing a protected retirement account. Creating a tax-exempt retirement account is a good idea anyway, but it can act as a buffer between the IRS and money set aside for spousal payments.
- Negotiating lower spousal payments. Because the tax break is no longer available, you have a very strong bargaining position in that you will be paying much more overall than your spouse. This is a great tool for negotiating a lower overall payment.
If you are considering divorce, the new legislation might be a good reason to postpone until the beginning of 2019. Since the payments you receive will no longer be counted as income, you should feel a significant financial relief when it comes to paying your taxes.
Still, that doesn’t mean you shouldn’t be wary about the long-term impacts of this bill.
Identify your state restrictions and impacts. In some states, like New York, there are clear parameters for determining spousal support costs. In others, like New Jersey, there are not. In these state this, the loss of the tax credit may be a huge roadblock to gaining a fair spousal support settlement.
Keep your divorce or separation documentation clear.
Don’t fall into the trap of thinking that your spousal support settlement should or can be used in place of child support. These are two different items and both need to be addressed in your documentation.
Be aware of financial investment limitations. Since many IRA investment funds require money to be taxed before being allocated, it’s important to speak with a financial manager who can give you good alternatives and investments that qualify under the new law.
Those Considering Divorce or Separation Document Modifications in 2019
If you have a current document in place and are planning to modify it, you have the right to incorporate the new legislation as you deem beneficial. This makes the most sense for spousal payment recipients who want to avoid the additional tax expense.
Remember, though, that modifications like this are not going to be taken lightly by the payer who will be taking on that expense. In some cases, the legal expense of trying to get the modification pushed through may outstrip the financial benefit.
Make sure that the financial gain is worth the fight, and consult your financial and legal team before making that final decision.
Our Final Advice? Be Nice. Ish.
The Tax Cut and Jobs Act means you have huge financial reasons to be as cordial as possible throughout the increasingly sticky divorce process. As the tax burden shifts more towards the payer of spousal support, there are likely to be angry backlashes and a general unwillingness to negotiate higher payments.
The key to it all, however, is recognizing that collaborating on divorce in 2019 is going to be harder and more important than in years before. Despite your differences, the goal is still the same—financial stability for the long-term.
It will be very easy to drag out and complicate a divorce under the new law, making it expensive for both parties. Being willing to understand the other side and meet them as close to halfway as possible will be the only way that you both get what you want.
How do you think the new tax law will impact you in 2019?
Worried about how much it will cost to settle your case?
Take the guesswork out of divorce fees. Click here to learn more.