Divorce is seldom a simple process, least of all from a financial perspective – and thanks to the recent passage of the Tax Cuts and Jobs Act (TCJA), a controversial tax reform bill touted as the largest overhaul of U.S. tax legislation in decades, it may become even more complicated. With the provisions of the TCJA, which became law in December 2017, set to take effect this tax season, it will be critical for divorcing spouses to understand the potential perils in order to engage in efficacious financial tax planning. Working with an experienced divorce tax attorney, like those at the Tax Law Office of David W. Klasing, will better ensure that you are amply prepared for both the short- and long-term tax consequences of a divorce, such as who may claim which deductions, who becomes liable for which taxes, the taxation of court-ordered alimony or spousal support payments arising from divorce, and the taxability or an transfers /distribution / sale of marital assets and property.
According to statistics from the Centers for Disease Control and Prevention (CDC), a total of 2,245,404 U.S. couples tied the knot in 2016. During the same period, another 827,261 couples filed for divorce.
With close to a million marriages ending in divorce each year in the United States – the annual figure has ranged anywhere from about 800,000 to 955,000 over the period from 2000 to 2015, according to government data compiled by Divorce Magazine – a substantial portion of the population will, at some point, be forced to confront the tax consequences of marital dissolution. Unfortunately, even in the most amicable of proceedings, these consequences are often complex and far-reaching, impacting issues that range from the taxation of alimony and mortgage payments to the enforceability of prenuptial (or postnuptial) agreements.
In the absence of professional tax guidance, divorcing spouses can end up owing thousands more than they anticipated – or losing assets they believed were untouchable. The question is, how might these types of issues, which have always posed financial planning challenges to divorcees, evolve as the TCJA takes effect?
Perhaps most notably, alimony payments will be dramatically impacted – as will the recipients who depend upon them to bridge financial gaps.
With regard to divorce proceedings, the party who pays alimony is alternately known as the “obligor” or “payor” spouse, while the recipient is called the “obligee” or “payee.” Prior to the passage of the TCJA, payor spouses could deduct alimony payments from their federal income taxes, while payee spouses were taxed in accordance with their individual income tax brackets (which, taxpayers should keep in mind, were also altered by the TCJA). This system, commonly dubbed the “divorce subsidy” by detractors, enabled both payee and payor to achieve substantial tax savings – for example, as much as approximately 50% for certain payors, depending on the circumstances.
Under the TCJA, as of January 1, 2019, alimony is no longer tax-deductible for the payor, nor is alimony income subject to taxation for the payee. While this may benefit some taxpayers, others are likely to feel the pinch as payors lose financial incentives. Indeed, experts have already estimated that divorcees will collectively miss out on approximately $6.9 billion over the course of the next 10 years.
Moreover, these changes could also cause divorcees to lose the ability to contribute alimony income to IRAs (Individual Retirement Accounts/Arrangements), making it harder to plan strategically for retirement. As the Internal Revenue Service (IRS) notes in Publication 590-A (2017), Contributions to IRAs, “For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.” Notice that the IRS specifies “taxable alimony” – which spousal support is, under the TCJA, no longer considered to be.
Though significant, spousal maintenance isn’t the only tax issue that could create financial turbulence in post-TCJA divorce proceedings. While renters may be safe, homeowners are likely to face headaches resulting from the loss of various tax breaks – for example, new caps on the mortgage interest deduction (which ultimately shrank from $1 million to $750,000).
Taxpayers with prenuptial or postnuptial agreements could also face hassles if any provisions thereof were impacted by the reform bill – a likely scenario for many, considering the sheer breadth of financial issues that can be addressed by such agreements. For example, the aforementioned changes to the taxation of spousal maintenance might render some or all alimony-related provisions of a pre- or postnuptial agreement invalid, which would, of course, necessitate revising its terms to reflect the TCJA. Thus, even if your post- or prenuptial agreement seems relatively straightforward, it would be wise to review its provisions with an experienced tax attorney or CPA who has a history of successfully resolving issues specific to divorce, separation, and annulment. This will be particularly critical if you or your spouse owns real property, operates a small business, has received or will receive a substantial inheritance, or is considered a high net worth individual.
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For better or worse, the TCJA has, as promised, ushered in an era of change when it comes to tax laws in the United States. Regardless of whether they are single, engaged, married, separated, or divorced, savvy taxpayers will rethink their tax planning strategies to take advantage of the new legislation (while side-stepping its potential pitfalls).
At the Tax Law Office of David W. Klasing, our award-winning team has spent more than 20 years helping U.S. citizens, non-citizens, and business owners navigate state and federal tax issues that can arise from divorce in California, including tax evasion and divorce, innocent spouse relief, tax preparation, and estate planning. Whether the issue at hand is civil or criminal in nature, rely on our diligent and dedicated Los Angeles tax attorneys for total tax assistance throughout every stage of the divorce process. Contact us online to schedule a reduced-rate consultation or call the Tax Law Office of David W. Klasing at (800) 681-1295 today.
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