I sat down with Jill Boynton of Cornerstone Financial Planning to find out.
Currently, the person receiving alimony pays income tax on the alimony received. The alimony payer is able to deduct alimony payments from his/her income, reducing the payer’s tax burden.
Jill indicated that beginning January 1, 2019, for any alimony orders issued from that date forward, the tax burden for alimony will no longer shift from the payer to the recipient. Instead, it will remain with the payer, who is often in a higher tax bracket than the recipient. The new law could mean that the payer can’t afford to pay as much alimony because there is no tax break, and the recipient will receive less alimony.
Say, for example, under the current law, a person making $100,000 per year agreed to pay $20,000 per year in alimony to another person. The cost of alimony to the payer is $20,000 before tax dollars. The payer will pay income tax on $80,000, not $100,000. The payer will not be taxed on that $20,000 – it is as if the income were simply transferred from the payer to the payee. In addition, the payment might drop the payer into a lower tax bracket, in this instance from 24% to 22%. So the payer would pay $17,600 in income tax, rather than $24,000.
The person receiving the alimony under the current law will pay income tax on the $20,000 received (plus any other income that person may have). Thus, the recipient is not receiving the full $20,000 – it is $20,000 minus the income tax the recipient must pay on it. Depending on the recipient’s tax bracket, the recipient could be taxed on this at a rate of 12% or more costing the recipient $2,400 or more in taxes.
Here is a simplified example of how the new law affects the payor: under the new law if a person making $100,000 per year agrees to pay $20,000 per year in alimony to another person, the cost of alimony to the payer will be $20,000 in after tax dollars. This means that the payer will still pay income tax on $100,000. The payer’s tax bracket will remain the same – 24%, rather than dropping to 22%. The cost of alimony to the payer is thus significantly higher, both because alimony represents after tax dollars and because the payer remains in the same tax bracket. The payer will pay around $4,800 more in income tax than if alimony could have been deducted. In this scenario, the recipient will receive the full amount - $20,000 – and will not pay income tax on any of it.
In situations like this where a payer’s tax bracket is no longer reduced, as more money is going to the federal government for taxes, there is less available for the payer to give to the recipient. This means that the recipient may receive less than the recipient would have received under the current law.
If you have a final alimony order currently in effect, Jill believes that the current law will continue to apply. The new law will not have a retroactive effect.
However, if you have a temporary alimony order in effect, Jill recommends that you speak with your accountant and attorney before agreeing to have that temporary order become a permanent order. Things will get particularly tricky for those with temporary orders on alimony before January 1, 2019, and final orders on alimony after January 1, 2019.
Jill also indicated that as of January 1, 2019, you can no longer deduct legal fees associated with negotiating and litigating alimony.
Personal Exemptions Are Gone
Jill indicated that this tax bill has done away with personal exemptions. You can no longer claim $4,050 for yourself, your spouse, and any dependents you may have. There will no longer be an issue as to claiming children as dependents, as children may no longer be claimed as dependents.
The Child Tax Credit Has Doubled
The law has been that if you claimed a child as a dependent, you could claim the child tax credit for that child. Now, you can no longer claim a child as a dependent, but you can claim a child tax credit. Jill recommends that you talk to your accountant or attorney about how to handle the child tax credit in your divorce.
The Standard Deduction Has Nearly Doubled
Single filers will have a standard deduction of $12,000. Those filing as Head of Household will have a standard deduction of $18,000.
If You Itemize
There is a new cap on deductions for mortgage interest, sales tax, property tax and income tax paid. These deductions together are capped at $10,000. Many homeowners in Maine and NH will be impacted by this cap.
You can still deduct up to $2,500 per year in student loan interest.
Health Insurance Mandate Repealed
When people are married, they often have health insurance coverage together through one person’s employer. When people divorce in Maine and NH, it is often impossible for a divorced spouse to continue to receive health insurance coverage through the other divorced spouse. If a divorced spouse does not have a job which provided health insurance coverage, that person may turn to the Affordable Care Act for health insurance coverage.
Jill indicated that while a person may turn to the Affordable Care Act for health insurance coverage going forward, there is no longer a mandate in place. There will be no fine to pay if a person chooses instead to go without health insurance coverage.
How Long Will These Changes Last?
A lot of the provisions expire in 8 years. Jill recommends that you talk to your accountant and your attorney about the long-term effect of these changes.
About Jill Boynton
Jill Boynton is a Certified Financial Planner with Cornerstone Financial Planning. She offers financial coaching services to divorcing couples and individuals. She provides financial information, not legal advice or tax advice. Cornerstone Financial Planning has offices in Newington, NH, and Portland, Maine.
This article does not constitute legal advice or tax advice. Please contact your attorney and/or accountant with specific questions about how the new tax law will affect you.