Marital Dissolution Planning Post TCJA
- Written by Sidney Kess, CPA, J.D., LL.M.
The IRS reports that nearly 600,000 taxpayers claimed an alimony deduction on their 2015 returns (the most recent year for statistics) (https://www.irs.gov/pub/irs-soi/soi-a-inpd-id1703.pdf). The Tax Cuts and Jobs Act of 2017 (TCJA) (P.L. 115-97) made important changes in the tax rules for alimony. These changes have a ripple effect throughout the tax law, impacting a number of other provisions. Here are the basic rules for alimony and their impact on other tax provisions in light of TCJA.
Currently, payments that meet the definition of “alimony” under Code Sec. 71 are deductible by the payer and includible in gross income by the recipient. There are no dollar limits on these amounts. These rules continue to apply to payments under divorce or separation agreements executed before January 1, 2019.
However, alimony will not be deductible, or includible in the recipient’s gross income, for any divorce or separation instrument executed after December 31, 2018, as well as those executed earlier but modified after 2018 expressly providing that the repeal of qualified alimony and separate maintenance rules apply. In effect, those with post-2018 divorces will see alimony treated the same as child support (i.e., nondeductible by the payer and nontaxable to the recipient).
Clearly, this tax law change will impact negotiations for alimony payments for new marital dissolutions. Those considering modifications of existing arrangements have leeway in their course of action. They can continue to apply the old rules unless they agree to have the new rules apply by expressly referencing the TCJA deduction repeal. Reasons to consider opting for TCJA treatment include changes in the income levels of the payer and/or recipient. For example, the payer may be in a lower bracket and won’t benefit greatly from a deduction, or the recipient may be in a higher bracket and prefer tax-free income.
Any modifications should take the “recapture rule” into account. This rule requires the payer to recapture (i.e., report as income) some amounts previously deducted. The rule is triggered when alimony paid in the third year of the first three-year period is more than $15,000 less than in the second year or if the alimony paid in the second and third years decreases significantly from the amount paid in the first year. This rule has not been changed by the TCJA.
It should also be noted that post-2018 decrees and agreements do not have to conform to the definition of alimony. Whereas deductible alimony payments under pre-2019 decrees and agreements must be in cash, payments to a spouse or former spouse under post-2018 decrees and agreements need not be in cash. It would seem, for example, that a transfer from a qualified retirement plan pursuant to a qualified domestic relations order (QDRO) may be used to make a lump-sum alimony payment by the payer. In the same vein, perhaps stock or realty could be used to satisfy a lump-sum alimony payment. And it would not matter whether payments end on the death of the recipient.
The tax treatment of child support has not been changed by the TCJA. Payments are not deductible by the payer or taxable to the recipient (Code Sec. 71(c)).
Dependency exemptions. The dependency exemption applies for 2017 returns. The custodial parent can waive the dependency exemption to allow the noncustodial parent—often the person providing the child support—to claim the exemption. This waiver is made on Form 8332, Release/Revocation of Release of Claim to Exemption for Child By Custodial Parent.
The TCJA suspends the dependency exemptions for 2018 through 2025. Despite this suspension, the concept of a dependent remains viable through these years for various tax provisions (e.g., child tax credit) and should not be overlooked.
Existing divorce agreements likely have factored in the tax benefit for dependency exemptions, as well as the tax rates that the payer is subject to. In other words, one parent may have agreed to pay a certain amount with the understanding that he/she could claim an exemption for the child. For example, in 2017, the $4,050 exemption amount saves a parent in the top tax bracket more than $1,600 in taxes. If the parties renegotiate agreements after 2018 to make changes in child support, it is important to note the impact of the language on alimony (i.e., whether the parties opt for pre-2019 treatment for alimony).
Child tax credit. For purposes of the child tax credit (Code Sec. 24), which was greatly expanded, a taxpayer can claim a credit for a:
• Qualifying child. The child (the taxpayer’s child, sibling, or descendant) must be under age 17 by the end of the year and not provide more than half of his/her support. Usually the child must live with the taxpayer for more than half the year but there is an exception in the case of divorce. The credit is up to $2,000; up to $1,400 can be refundable.
• Qualifying dependent. This can be a qualifying relative of any age as long as he/she would qualify as a dependent under the old dependency rules (Code Sec. 152(b)) (e.g., a taxpayer’s child who is over age 17). The nonrefundable credit is up to $500.
Education. Another change by the TCJA is the ability to use up to $10,000 annually from a 529 plan to pay for elementary and secondary school. Those with agreements requiring a parent to pay out of pocket for these costs may need to be revisited.
IRAs continue to be an asset that can be addressed in a marital dissolution. The rules have not been changed by the TCJA. Courts may direct the account owner to transfer some or all of the funds to the spouse or former spouse. The transfer is not taxable to the account owner if it’s made pursuant to a court order and done by directly transferring a fixed dollar amount or percentage of the account to the spouse’s IRA or by setting up a new IRA to which these funds are transferred. If there’s a court order but the account owner transfers funds to his/her checking account and then writes a check to the spouse, the account owner is taxable (see Kirkpatrick, TC Memo 2018-20).
A recipient of taxable alimony can count it as income for purposes of making an IRA contribution. Thus, a nonworking individual receiving alimony in 2018 can base an IRA contribution on alimony payments. In 2019, those receiving alimony under a divorce or agreement finalized before 2019 can continue to treat the taxable alimony as compensation for purposes of IRA contributions.
However, for those who receive nontaxable alimony starting in 2019, the opportunity to make IRA contributions based on alimony payments no longer exists.
It will be busy for matrimonial attorneys with clients who want to finalize agreements before 2019 as well as for those who may want to delay the process. There is much to consider for these individuals and their families…and taxes should be an important factor is reaching a marital dissolution.
Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman, consulting editor to CCH and Of Counsel to Kostelanetz & Fink.