At the end of 2017, Congress passed the Tax Cuts and Jobs Act. This sweeping tax reform will have a significant impact on divorce. It is the consensus that the largest impact of the tax reform for divorcing individuals deals with the taxability of alimony. Alimony payments are currently defined as income to the recipient and are tax deductible by the payor. Effective January 1, 2019, for all new alimony obligations established through either a settlement agreement or court judgment, the prior tax classifications are no longer valid. This will result in alimony payments receiving no tax status in terms of deductibility or recognition of income. It is important to note that the Tax Cuts and Jobs Act will not impact the classification of alimony obligations established prior to December 31, 2018. With the deadline looming, it is safe to say that many individuals will be rushing to the courthouse to finalize their divorce prior to the end of this calendar year.
With alimony payments classified as non-deductible, the ability to shift income to the lower income tax bracket of a recipient is no longer an option. This will more than likely provide less after-tax cash flow to both parties. At all income levels, this could result in a significant reduction of available support. When negotiating settlements or preparing for trial, it will now be necessary to further explore each individual’s after-tax cash flow and identify their respective effective tax rates to secure an alimony award that is equitable. This likely will increase the cost of a settlement, as the involvement of a qualified tax professional may be necessary to identify the applicable tax rates and impacts on cash flow. While the Tax Cuts and Jobs Act was meant to simply tax filings for many individuals, it surely did not have the intended effect for future alimony negotiations.
The updated tax code also will impact child-related issues in three distinct areas. In regard to child support, as previously highlighted, with the elimination of the ability to deduct alimony payments, after-tax cash flow will decrease. The combined net income of two parties divorcing in New Jersey is a controlling factor when child support awards are calculated. With less net income available in alimony cases, the child support obligations established under the New Jersey Child Support Guidelines will also decrease.
The Tax Cuts and Jobs Act eliminated the exemption deduction for dependent children, but doubled the child tax credit to $2,000. The doubling of the child tax credit is significant, as the previous exemptions simply decreased your taxable income, while the child credit reduces your actual taxes. Additionally, the updated tax code increased the income phase-out threshold for these credits to include more families, with the joint filing threshold increasing to $400,000 and the single filer increasing to $75,000. As more individuals will qualify for this tax credit, it is important to include the same when negotiating child support, especially in the discussion of each party’s after-tax cash flow.
Lastly, the modified tax code has expanded the utilization of 529 Plans towards public or private elementary, middle and high schools. Under our prior tax law, 529 Plans could only be utilized without penalty towards a child’s college educational costs. With earlier access to funds in these plans, child support obligations in the form of contributions towards private tuition can now be modified to include savings that were previously “earmarked” for college. With the long-term use of such accounts and compounding tax-free growth potentially outweighing the short-term benefits for applying the funds private elementary, middle or high school costs , it is important to identify how these accounts will be applied through any settlement agreement.
With the taxability of alimony modifying at the end of this calendar year, there are many issues to navigate in terms of establishing an appropriate support obligation. The attorneys at Ulrichsen Rosen & Freed have the experience to address these issues. If you have any questions on this topic, do not hesitate to contact our office.