Tax Changes Affecting Family Law
The Tax Cuts and Jobs Act (TCJA) made far-reaching changes including those that are relevant to divorce. Here are some highlights of the TCJA’s tax modifications that affect family law.
Repeal of Alimony Deduction
The TCJA repealed the alimony deduction and corresponding income inclusion affecting every new divorce involving alimony after Dec. 31, 2018, and grandfathered in all agreements and court orders dated prior to Jan. 1, 2019. Under the prior law as provided for by IRC Sections 61, 71 and 215, alimony and separate maintenance payments were deductible as an adjustment to gross income by the payor and includible in gross income by the recipient. Under the old IRC provisions, the parties could collectively benefit from the income tax rate differential and tax savings.
All divorce or separation instrument executed after Dec. 31, 2018, fall within the scope of the TCJA’s alimony repeal. Any divorce or separation instruments executed on or before Dec. 31, 2018, and modified after Dec. 31, 2018, are also impacted if the modifications expressly provide that the repeal provisions apply.
The TCJA also repealed IRC 482 that dealt with alimony trusts. Under the prior law, income of a trust paid to the ex-spouse was taxable to the recipient and not to the grantor. The repeal eliminates that rule.
Personal Exemptions and the Child Tax Credit
Personal exemptions are suspended from Jan. 1, 2018, through Dec. 31, 2025. The TCJA increased the Child Tax Credit to $2,000 (limiting the refundable portion to $1,400 in 2018) for each qualifying child under age 17. A child must have a Social Security number in order to qualify. The income phase-out for the child tax credit increased in 2018 to $200,000 ($400,000 for joint filers).
Lost Miscellaneous Deductions
Prior to the TCJA, IRC Section 212 allowed a miscellaneous deduction (subject to a 2-percent of AGI limit and a phase out) for legal and accounting fees related to taxable alimony, divorce-related tax planning and related analysis, addressing innocent spouse relief, etc. The TCJA suspends the miscellaneous deductions through Dec. 31, 2025. Taxpayers should consider using retirement funds to pay any professional fees related to splitting of Individual Retirement Accounts or ERISA plans (e.g., QDRO fees).
Impact on Valuations in Divorce
Valuations of businesses and business interests for equitable distribution purposes will likely be impacted. The TCJA reduced corporate income tax rates from 35 percent to 21 percent. In addition, a new deduction of 20 percent for business pass-through entities was added. Immediate deductions for capital expenditures spent on equipment, furniture and fixtures and alike are also provided for. This means there will be less cash needed for business-related income taxes and more after-tax cash available to the owners/partners/shareholders.
Most business valuations in family law utilize the income approach. The valuation methods under the income approach usually consider either some form of after-tax earnings or cash flows attributable to the interest being valued, and those earnings and cash flows are tax affected. Historically, business analysts used a range of income tax rates for this purpose, relying on various valuation theories. Valuation professionals will need to consider the impact of the additional cash flows resulting from the tax rate cuts and the special 20-percent deduction available to the pass-through entities.
Information contained in this article is not intended as a thorough in-depth analysis of fact patterns and issues; it is not a substitute for a tax opinion.
Henry Rinder, CPA, ABV, CFF, CGMA, CFE, is a member of the firm at Smolin, Lupin & Co., P.A. He is a past president of the NJCPA.
This article appeared in the January/February 2019 issue of New Jersey CPA magazine. Read the full issue.