By Ethan H.R. Hitchcock, CPA/ABV, ASA | Valuation and Forensic Services Manager | Valuation and Forensic Services Team
The Tax Cuts and Jobs Act (“TCJA”) enacted by Congress on December 22, 2017, is the most substantial change to the U.S. tax code in decades. Divorce and separation arrangements are areas significantly impacted by the TCJA as changes to alimony, corporate tax rates, and other tax deductions/credits will materially alter divorce agreements going forward.
Currently, alimony or separate maintenance payments may be deducted “above the line” by the paying spouse for tax purposes and is included as income to the recipient. However, under the TCJA, alimony or separate maintenance payments will no longer be tax deductible by the payor, and the recipient of alimony will not include the payment in taxable income. The new law is effective for divorce agreements executed after December 31, 2018, and will not affect an agreement in place prior to the effective date (the new alimony provision is not retroactive). As payors will no longer get the benefit of tax deduction starting in 2019, alimony payments will likely decline to keep the payor’s out-of-pocket expense constant.
If you’re thinking to yourself that this seems like a lose-lose for both parties, you’re correct! Therefore, all else being equal, there is a significant financial incentive for individuals to finalize divorce agreements before January 1, 2019.
Corporate Tax Rates
Perhaps the biggest change implemented by the TCJA is the reduction in the corporate income tax rate for C Corporations from a graduated scale with rates up to 35% to a flat 21% rate. Pass-through entities such as partnerships, limited liability companies, and S Corporations were also impacted by the TCJA, though the changes are more complex and beyond the scope of this article.
In general, lower tax rates result in increased cash flow to shareholders and business owners, which, in turn, results in an increase in business values. Therefore, in a divorce where a spouse owns an equity interest in a business, the change in the tax rates may result in an increase in the value of the business for purposes of equitable distribution.
Other Tax Deductions/Credits
The TCJA temporarily eliminates individual tax deductions for miscellaneous itemized deductions subject to the 2% floor for taxable years beginning after December 31, 2017, and before January 1, 2026, removing the tax benefit of expenses such as professional fees incurred while pursuing alimony. Alternatively, spouses receiving alimony will likely be reporting reduced income which may make them eligible for credits such as the Child Tax Credit. In addition, the question of which spouse gets to claim the kids on their tax return loses some importance with the repeal and elimination of the personal and dependency exemptions for taxable years beginning after December 31, 2017, though Child Tax Credits and education tax credits, along with the emotionally charged nature of the issue, ensure it will remain closely contested.
As the above examples indicate, the TCJA has significantly changed the financial landscape when it comes to divorce. Accordingly, it is imperative that the financial expert and attorney work together to determine the best course of action given the particular facts and circumstances, venue, and the relevant case law.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.