The new “Tax Cuts and Jobs Act” will affect couples who are divorcing. Child support and spousal support are the main areas affected. Here is a very basic explanation of the main changes and the general net effect of each. You may want to consult with a divorce, financial or tax professional to understand the new law’s impact on your specific situation. The provisions below are set to expire in 2025.
New Tax Law
1. Spousal support. Starting in 2019 with new divorce agreements, alimony for federal income tax purposes will no longer be deductible by the payer or taxable for the recipient. General net effect: less after-tax income for the higher earner and therefore lower amounts of spousal support. However, for California state income tax purposes, spousal support is still deductible for the payer and treated as taxable income for the recipient.
2. Personal exemptions. These have been eliminated as of tax year 2018. Previously a personal exemption of $4,050 could be claimed for each spouse and each qualifying child. Divorcing spouses could negotiate who would claim the exemption for each child. Often agreements would be reached for the higher-earning spouse (in a higher tax bracket) to claim these exemptions since this would result in more money being available for support. Such agreements are no longer possible. General net effect: less support.
3. Child tax credit. To some extent, replacing the personal exemptions for children is an increase in the child tax credit from $1,000 to $2,000 for children under the age of 17. The income limits for being able to claim the child tax credit have been raised significantly. So more parents will now be able to claim the credit. It will be possible to negotiate which spouse will claim the child tax credit. General net effect: significant tax benefit for whichever spouse claims the credit; if this is the higher earning spouse, increased support is possible.
4. Individual income tax rates. Rates have been lowered for all income levels – until the reductions expire in 2026 along with all the other changes to individual (non-corporate) taxation. General net effect: more after-tax income for both spouses and more support from the higher earner.
5. Standard deduction amount. This has been essentially doubled for all filing statuses. This will eliminate the desirability of itemizing deductions for many spouses. For individuals using the “Single” filing status, the standard deduction amount has been raised from $6,350 to $12,000. General net effect: more after-tax income and more support from the higher earner.
For those who can file as “Head of Household,” the standard deduction amount has been raised from $9,350 to $18,000. Only those who provide a home to a qualifying child for more than half of the year can use this filing status. General net effect: more after-tax income for the primary home provider and therefore a reduced need for support.
6. Deductibility of state income taxes and real estate taxes. This is now capped at $10,000 per year. Many spouses in California, especially homeowners, currently pay much more than $10,000 in state income tax and real estate tax. General net effect: more federal income tax for these spouses and therefore less money available to pay support.
7. Home ownership. Two of the main financial benefits of owning a home have been the deductibility of real estate taxes and mortgage interest. As noted in the paragraph above, for many spouses the ability to deduct real estate taxes will now be seriously limited or eliminated. For new mortgages after Dec. 15, 2017, only the interest on the first $750,000 of mortgage debt is deductible. General net effect: less financial benefit of owning a home.
New Tax Law and Divorce – Some Other Important Changes
8. Home equity loans / lines of credit. Interest can no longer be deducted on new and existing loans. This will reduce after-tax income.
9. Pass-through businesses (generally small business owners who pay themselves out of the business earnings). Many sole proprietors, partners, LLC members and S-corporation shareholders will be able to claim a standard deduction of 20% of their pass-through income. For many this will increase their after-tax income.
10. AMT and phaseout of itemized deductions. Fewer taxpayers will be subject to the Alternative Minimum Tax (AMT). There is also no longer a phaseout of itemized deductions. Both of these changes will benefit high-income taxpayers.