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Filing tax returns can already be burdensome, and for divorcing couples, recent significant changes to federal tax laws are likely to further complicate matters. The Tax Cuts and Jobs Act reverses the law created nearly 80 years ago that aimed to ease the post-divorce transition from paying taxes jointly to separately. Family lawyers are advising their clients on the Internal Revenue Service’s guidance in 2020 and beyond, and how the law can affect each spouse’s tax liability. Individuals going through a divorce already suffer financial stress, and the new tax measures will deepen those impacts for those whose divorces were finalized in 2019 and later.
One of the law’s biggest changes for divorce is the elimination of the deduction for alimony payments. Alimony refers to spousal support payments that meet the requirements for “alimony or separate maintenance payment” under the federal tax code. The alimony tax deduction had incentivized the higher-earning spouse to provide more alimony to the lower-income spouse by providing a tax benefit. Now, the higher-earning spouses would have to earn more income to pay the same level of support had they gotten divorced before the alimony tax deduction was eliminated. The savings were particularly significant for top earners in high-tax states.
This “divorce subsidy,” in some cases, helped prevent divorces from going to trial, especially when the divorce was already financially contentious. According to several family lawyers, the updated alimony rules now complicate how divorces are settled. High-income divorcing spouses are aggressively fighting to pay less in alimony, since the government no longer subsidizes these payments via the tax deduction.
It may initially seem that not having to pay taxes on received spousal support would be beneficial to the recipient. But with the elimination of the tax break for the paying spouse, the total amount of money available to the family in crisis may be significantly reduced and may ultimately result in the lower-earning spouses (typically women) receiving less support in the long run. Without the tax deduction for the paying spouse, child support payments also could be affected, since the calculation of those payments generally depends on first determining the award of spousal support payments.
The new law also repealed the section of the Internal Revenue Code that dealt with taxation of alimony trusts. Previously, the income of a support trust payable to a divorced spouse would be taxable income for the beneficiary spouse, rather than for the grantor spouse. Now, this is no longer the case. Grantor spouses may have to pay the income tax on trust income even though they don’t receive the distributions from the trust.
Despite this change in the tax treatment of alimony trusts, there may still be benefits to creating trusts in divorce, particularly if one or both spouses wish to protect assets for their children and future descendants from creditors—or minimize direct interaction with an ex-spouse, as a trustee is responsible for making the support payments.
The new law also eliminated the $4,050 exemption for each dependent child through 2025. Only one parent at a time may claim a child as a dependent, and it’s typically the parent with whom the child lives with for more than half the year. The child tax credit, however, has doubled from $1,000 to $2,000. The new tax law did not change the tax treatment of child-support payments; these payments still are neither taxable for the recipient parent nor deductible by the parent making the payments.
Family law attorneys and other advisors are counseling divorcing clients on the impacts of the federal tax law and how they can affect their clients’ bottom line. Aside from the emotional issues involved in many divorces, there are also significant tax and financial considerations for clients to consider.