How Will the 2018 Tax Code Changes Affect My Divorce?

For years, if not decades, spouses going through a divorce, as well as attorneys, have been able to reply on two constant legal doctrines tied into income tax and dissolution of marriage. Specifically, the first of those two items was the fact that under IRS Code, 26 U.S.C. 71, spousal alimony (maintenance) was allowed to be deducted from the paying spouse’s income. Conversely, the spouse receiving maintenance was required to declare the funds received as income on his or her taxes. The second item relates to the right to claim the dependency exemption for a child. Currently, Colorado Revised Statute 14-10-115 states that the right to claim the dependency exemption shall be allocated between the parents in proportion to their contributions to raising a child. In practice, this has translated to family law courts allocating the right to claim the exemption, or exemptions, proportionate to the parties’ incomes. The sweeping changes to United States Tax Code enacted in late 2017 turn both doctrines completely upside down and leave people going through a divorce, their attorneys, and family law courts in the position of having to guess what the overall impact of the new legislation will be.

As relates to spousal maintenance, the tax ramifications have been something often considered in cases, both by the payer and the receiver. For either side of the equation, the analysis tied into their net cash flow. Though the paying spouse knew he or she would be paying ‘x’ number of dollars each month, they also knew that there would be a recoupment of some of those proceeds on the back end via the tax savings. For example, if husband’s income was $150,000 per year and he was in a 25 percent tax bracket, his tax would approximately be $37,500. If husband paid out $3,000 per month in alimony under this scenario, he could reduce his income on his 1040 form by $36,000, thereby lowering it to $114,000. That reduction in income not only could change his tax liability from a simple mathematical standpoint, but would also potentially lower his tax bracket, thereby providing further tax savings. Commencing with divorces filed after 2018, that tax benefit afforded to payers will be gone.

Commencing with divorce cases filed after 2018, the receiving spouse will derive a benefit in that he or she will no longer be required to pay taxes on the alimony received. Using the example above, if wife receives alimony of $36,000 per year as her only source of income, should would be required to pay tax on that amount. If we presume a 10 percent tax rate, her net alimony would be $32,400. With the new legislation, she is keeping approximately $300 more per month in her proverbial pocket, which might be payment of utilities and car insurance. The benefit for the recipient is huge. The new tax laws will conceivably have an impact on how alimony in a divorce case is negotiated. It will also likely have an impact on how courts enter alimony awards and view alimony cases. In a broader sense, it may necessitate the Colorado legislature rethinking the 2014 maintenance statute and the maintenance formula set forth therein. Only time will tell. What is almost certain is that the federal government will ultimately receive greater tax revenue based on this change in the law.

As relates to child support, the 2017 changes to the tax code do away with the personal exemptions people might claim on their returns, while increasing the standard deduction. The benefit Colorado law afforded child support payers via the right to claim a child for dependency exemption purposes, regardless of whether that child lived with that parent a majority of the time, will now be gone. The question becomes one of where courts and the law go from here? Under current tax code, the head of household distinction and benefits that flow from that, go only to the parent with the children the majority of the time. The standard deduction does as well. Colorado statute makes no provision for claiming head of household, just the dependency exemption. Regardless, federal law would govern. In cases in which the parties have equal parenting time, allocating the head of household rights in an alternating year fashion is certainly something parties could agree to. Conceivably, in cases of equal time, courts may find they have the authority to enter orders regarding alternate head of household rights in 50/50 cases. Traditionally, this has been strictly governed by IRS Code. Ultimately, the Colorado legislature may find a way to adapt to the new federal changes, so long as such an adaption does not contradict federal law. For now there is no stated solution and, as with the changes to maintenance and taxes, the paying spouse, or parent, may ultimately lose out on a long standing benefit. For higher-income families, the elimination of the dependency exemption may have no impact. For any tax specific questions related to divorce, it is advisable for litigants to speak with a tax specialist, such as their CPA, for more concrete and subjective insights into how the new law will affect them.