As taxpayers struggle to understand the impact of what is being labeled “the most sweeping tax rewrite in decades,” the Law Office of Jennifer Guimond-Quigley has put together a three-part guide on the fundamental changes clients will face. This is the first part of that series.
The tax overhaul passed in 2017 has significant changes for individuals and businesses. Within the family law context, the changes encompass key provisions of the tax code, including the personal exemptions, child tax credits and the deductibility of maintenance.
Elimination of Personal Exemptions and Child Tax Credit Changes
The elimination of personal exemptions left many individuals and families concerned. However, the tax overhaul will double the childcare credit from $1,000 to $2,000. This credit can be claimed for each qualified child under the age of 17 in a given tax year. It is important to note that this is a tax credit, not a deduction. While a deduction reduces the amount of taxable income, a credit will reduce a tax bill. Therefore, a family with one child that owes the IRS $5,000 for the year can claim a child tax credit of $2,000 to reduce the bill to $3,000.
Additionally, taxpayers should be aware of the difference between a refundable and nonrefundable credit. A nonrefundable credit can be used to reduce a taxpayer’s bill all the way down to zero. Whereas, a refundable tax credit can be used even if a taxpayer has no tax liability in a given year. This means a family with a tax liability of $1,500 and a $2,000 refundable tax credit to claim, their tax liability will be reduced to zero and they will claim a refund for the additional $500.
Under the new law, up to $1,400 of the child tax credit is refundable. Previously, the child tax credit was nonrefundable. Starting in 2018, a family with no tax liability whatsoever can still claim a refund of $1,400 for each qualifying child. It should be noted that the refundable portion of the credit is capped at 15% of earned income in excess of $4,500. As long as the taxpayer has earned income of $13,833 or more, they are in the safe zone and will be able to capitalize on the $1,400 limit. If earned income is below $13,833, then they refundable portion of the credit will be reduced. As with the changes to the standard deduction and personal exemptions, the increase to the child tax credit is temporary and will expire after the tax year 2025.
Before these changes, parties to a divorce would routinely negotiate who would get the child exemption each year. Even though the exemption is now gone, it is clear that claiming a child still has tax benefits, so the practice of negotiating who will claim the child has not gone away. However, the language of the marital settlement agreement should reflect the correct purpose for claiming the child under the new law and contemplate the sunsetting of the current law.
Maintenance
One of the most impactful changes is the alteration to maintenance. Prior to the passage of the new law, maintenance payments were deductible to the payer and reportable as income to the payee. Under the new provisions as of January 1, 2019, payers will no longer be able to claim a deduction on their maintenance payments, and payees will no longer be required to report the payments as taxable income. This new provision will only apply to divorces executed after December 31, 2018. The law will not affect current agreements regarding maintenance and divorcees seeking to modify their current maintenance agreement may retain their tax deduction. Unlike the changes to personal exemptions, the standard deduction and the child tax credits, the maintenance changes will not sunset, and unless Congress takes any further action, are permanent.
With all of the tax changes, it is essential for individuals to speak with a trusted tax advisor who can navigate the tax code on their behalf. This will help taxpayers find the largest tax savings possible and assist them with planning for the future.
Due to the complex nature of the new changes, it is recommended that taxpayers consult a trusted tax professional to understand how taxes will change. Read more in our tax overhaul series in regards to financial planning and exemptions and deductions.