Old Divorce Agreements and the New Tax Bill

Could be a Win-Win for the Entire Family

 

The new Tax Bill could be titled the Family Law Attorney’s Income Relief Act.   The Tax Bill has an alarming impact on previously divorced couples with children.  The Tax Bill impacts all divorce agreements where child support and/or spousal support payments were negotiated based on income tax strategies.    The Tax Bill is without question a tax savings gift to those families that can navigate a divorce agreement cost effectively and efficiently.   Depending on the decree, it is doubtful that many family law attorneys know exactly how the courts might handle such situations.   Most divorce agreements crafted to maximize family income will no longer meet those goals under the new Tax Bill.      The Tax Bill could easily be a win-win situation for both parents adding as much as $8,500 annually to their income without regard to the individual but rather the Parents’ combined net spendable income.   But the savings available could be quite easily consumed in attorney fees.

 

If you are a party to a previous divorce decree that requires annual adjustments to maintain an equitable outcome, you need to begin your planning now.   If you are party to a divorce agreement that considered child tax credits as a means toward equitable settlement you need to begin your planning now.   If you are a party to a divorce agreement based on not being able to use a child tax credits and/or dependent deduction because those were phased-out for high-income earners in previous years, you may want to revisit your old agreement now.   Do nothing, and the only winner is Uncle Sam.

 

Most divorced taxpayers combined will receive an increase in their monthly net cash flow provided their individual income is less than $200,000.   But where those tax savings end up might surprise you and all that depends on how your divorce decree is drafted.   Here’s a short summary of the changes that will affect nearly all divorced taxpayers with children:

 

  • Lower individual income tax rates. Federal tax rates are between 10% and 37%.   In 2017, a single tax filer would hit the 25% federal tax bracket with $47,950 in annual taxable income.   In 2018, a single tax filer can have annual income of $82,500 before they enter the 24% bracket.
  • Maintenance (alimony) will no longer be tax deductible to the payor or taxable to the recipient for those decrees signed after 12/31/2018. The non-deductibility in most cases with combined income under $315,000 will tend to increase net annual after-tax cash flow as opposed to an alimony tax deduction due to the lower and expanded individual income tax rates.
  • Nearly doubles the standard deduction. The standard deduction for a single filer was $6,350 in 2017 and in 2018 it is $12,000.  For a married couple it is $24,000.
  • Elimination of the personal exemption. Along with the increase in the standard deduction the new Tax Bill eliminates the personal exemption deduction that was $4,150 per eligible person in 2017.
  • Expanded Child Tax Credit. The child tax credit increased from $1,000 to $2,000 in 2018 for those children under age 17.   In addition, $1,400 is refundable meaning you could still receive up to $1,400 per child even if you did not pay any federal income taxes.
  • Tax Credit for Non-Child dependents. The Tax Bill added an additional tax credit of $500 for other dependents such as children age 17 and over and/or grandparents that may reside with you as an example.

 

Let’s look at a Wisconsin divorced family of four below with two minor children, standard deductions, equally shared placement with Parent A and Parent B.  No consideration is given to voluntary pre-tax or post-tax payroll deductions.  Parent A is the primary breadwinner making $100,000 per year and Parent B is a part-time worker, part-time family caretaker and earns $25,000 per year.   Parent A pays Parent B $1,122 per month in child support and $1,263 per month in tax deductible support.   Both Parents’ stated goal is to substantially equalize their net spendable incomes and in 2017 they each enjoyed approximately $48,000 net after-tax spendable income.   The Tax Bill will save this divorced family of four over $4,674 in combined income taxes as compared to 2017.   That’s nearly $390 per month!  But if you think the new Tax Bill will retain a level playing field, think again.

 

Example #1

 

Party Income Child Support Spousal Support Tax Paid in 2017 Tax Paid in 2018 2017 Net Spendable 2018 Net Spendable
Parent A $100,000 -$13,462 -$15,156 -$23,043 -$19,731 $48,339 $51,651
Parent B $25,000 +$13,462 +$15,156 -$5,281 -$3,918 $48,337 $49,700
TOTAL $96,676 $101,351

Parent A and B’s combined net spendable income in 2017 was $96,676 and their combined net spendable income for 2018 is $101,351 increasing by $4,675.  But the increase in tax savings is not equal adding only $1,363 of the $4,675 savings to Parent B’s bottom line.   Surprisingly the Tax Bill totally changes the level landscape of previous agreements.   There is a whopping 24 different ways to file a tax return for a divorced family of four while sharing substantially equal placement of their minor children and each of those options create a different outcome.   Which one of those 24 different ways to file taxes is required in your agreement?

 

The below Example #2 is the same family as above except that Parent B has primary placement with the two minor children in 2017 and files as head of household and Parent A files as a single taxpayer.  No spousal support is paid but statutory child support was ordered by the court.   The Tax Bill could save this family $4,035 annually or $336 monthly in federal taxes as compared to 2017.   But that $336 per month in savings will go $224 per month to Parent A and only $112 per month to Parent B whom has full-placement of their two minor children.

 

Example #2 

 

Party Income Child Support Spousal Support Tax Paid in 2017 Tax Paid in 2018 2017 Net Spendable 2018 Net Spendable
Parent A $100,000 -$24,200 -$0 -$25,789 -$24,129 $44,111 $46,805
Parent B $25,000 +$24,200 +$0 +$3,950 +$5,288 $53,134 $54,475
TOTAL $97,245 $101,280

Consequently, the largest portion of the tax savings will go to the higher income earner and not remotely equitable.   But what about the loss of tax deductible alimony for those divorces completed after 2018?   Consider the above Example #1 and assume that Parent A and Parent B chose to modify their divorce agreement from tax deductible spousal support to non-tax-deductible spousal support for tax year 2018 and retain their goal of substantially equal net spendable income.     Their combined net spendable income would increase $5,515 annually or $460 per month and each of them will enjoy $230 per month additional net spendable income as compared to 2017.

 

 

Party Income Child Support Spousal Support Tax Paid in 2017 Tax Paid in 2018 2017 Net Spendable 2018 Net Spendable
Parent A $100,000 -$13,462 -$13,311 -$23,043 -$22,085 $48,339 $51,141
Parent B $25,000 +$13,462 +$13,311 -$5,281 -$633 $48,337 $51,141
TOTAL $96,676 $102,282

The loss of tax deductible spousal support increased their net spendable income as illustrated above.   So how will Parent B get Parent A to modify their agreement with an eye toward capturing tax savings?  First you need to get educated about the tax impacts on you and your former spouse in 2018 as compared to 2017.   There are numerous side-by-side divorce income tax calculators available on the Internet that could help you determine the savings if you are a “do it yourself” type of person.   You could contact a Certified Divorce Financial Analyst (CDFA) because they are specifically trained to provide this type of analysis.   You might want to use a family law mediator that is familiar with the new Tax Bill and the impact on divorce and learn all the possibilities together in a single meeting for cost efficiency.  It is common that the family law mediator is also an attorney and the one stop shop can help you determine your options and filing the necessary paperwork with the court to certify the agreed upon modification and be cost effective too.

 

Gerard G. Zielinski, CDFA

Gerard G. Zielinski is a Certified Divorce Financial Analyst at Divorce Financial Solutions LLC, in Milwaukee Wisconsin.