Tax Issues in Divorce

The Tax Cuts and Jobs Acts (TCJA)

The Internal Revenue Code (“IRC”) in Title 26 of the United States Code Service (“USCS”) governs federal tax in the United States. Over the past year, changes to the IRC have had an impact on American Tax Law that has rippled into family law.  The ripple effect began when Representative Kevin Brady (R) introduced the Tax Cuts and Jobs Act (“TCJA”) to the House of Representatives as Bill No. 115 H.R. 1 on November 2, 2017.[1] When President Trump signed the bill into law on December 22, 2017, the TJCA became the most significant change to the IRC since 1986. Though the changes affect all taxpayers in the United States, it particularly impact those taxpayers that seek a divorce.

Thus, family law attorneys must understand the effects that the IRC amendments have on equitable distribution and support. More specifically, these attorneys must understand how the amendments affect the sale of assets, tax returns for the year of divorce, liability for prior tax returns, dependency exemptions, and spousal support. This presentation expounds upon those tax issues.

Tax Considerations in Sale of Assets

Under IRC § 1041, transfers of property between spouses are treated as gifts for income tax calculations. Transfers of property between former spouses are also treated as gifts for income tax purposes so long as the transfer is incident to the divorce.[2] For the transfer to be “incident to divorce,” it must occur within one year of the divorce or be “related to the cessation of the marriage.”[3] This information is important because the transferred property is not taxable as a gift and may affect property settlement agreement negotiations.

Tax Returns for the Year of Divorce

Married tax payers may choose to file income tax returns under the married joint status or married separate status.[4] To file under the married joint status, the tax payers must be married on the last day of the tax year and they must both agree (have the intent) to file a joint return.[5] When a married couple files under the married joint status, they combine their incomes and allowable expenses. The joint return may be used where one spouse had earned an income. It may also be used regardless of whether or not the spouses lived together, so long as the parties are not legally divorced.

Liability for Prior Tax Returns

When a married couple files a joint tax return, the tax is computed based on their combined income.[6]  The married couple is jointly and severally liable for the tax due on any joint return.[7] In other words, the spouses are responsible as a couple and as individuals for the tax owed and any interest or penalty due on the joint return.[8] This is true even if a divorce decree states that a former spouse will be responsible for any amounts due on previously filed joint returns. Thus, one spouse may be held responsible for all the tax due, even if all of the income was earned by the other spouse.

However, a taxpayer may be eligible for relief from joint and several liability by requesting innocent spouse status.[9] To request innocent spouse relief, an individual must file Form 8857, Request for Innocent Spouse Relief with the Internal Revenue Service (“IRS”). Alternatively, an individual may file a statement similar to the Form 8857 under oath with the IRS.

There are three routes for relief as an innocent spouse. First, the traditional innocent spouse relief falls under IRC Section 6015(b). Under that section, any joint filing spouse may request to limit his or her own liability for any deficiency on the return as a result of the other spouse’s incorrect reporting.[10] However, this relief requires that the requesting spouse have had no knowledge of the other spouse’s erroneous tax reporting.[11] Second, the innocent spouse relief may fall under IRC Section 6015(c). Under that section, a joint filing spouse may request to limit liability for a joint tax return made when he or she is no longer married or legally separated from the other spouse.[12] Third, a joint filing spouse may request equitable relief under IRC Section 6015(f). To seek equitable relief, there is no relief available under sections (b) and (c) and, “taking into account all the facts and circumstances,”  it would be inequitable to hold the “innocent” spouse liable for the unpaid or deficient tax.[13] A copy of IRC Section 6015 is attached to this paper for ease of reference.

Dependency Exemptions

The TCJA has repealed dependency exemptions for 2018 through 2025. This means that a taxpayer may not claim a personal exemption deduction for the taxpayer’s self, spouse, or dependents under the TJCA during the time period after December 31, 2017, and before January 1, 2026.[14] However, on January 1, 2026, these exemptions will become available again unless the legislature decides to extend the duration of the requirement beyond 2025. It is worth noting that taxpayers were permitted to exclude $4,050 for each dependent in 2017.[15]

Child tax credits are available to taxpayers who have a child under 17 years of age if the child has lived with the taxpayer for at least half of the year. The TCJA has increased the maximum child tax credit available from $1,000 (2017) to $2,000 (2018) per qualifying child. In other words, the TCJA has doubled the maximum tax credit available per child since 2017.[16] To claim the child tax credit, the taxpayer must be sure to claim the child as a dependent.[17] The TCJA also includes a new credit of up to $500 for each dependent who does not qualify for the child tax credit.[18]

Income Tax and Spousal Support

Under current law, spousal support is tax deductible by the payor and taxable to the recipient.[19] This means that the person paying spousal support may deduct spousal support payments on his or her tax return. The support payor typically earns more than the support recipient, placing him or her in higher income bracket. Accordingly, the current law is beneficial to both parties.

However, Section 11051 of the TJCA repealed the deduction for alimony or separate maintenance payments from the payer spouse and the corresponding inclusion of the payments in the gross income the recipient spouse.[20] This means that alimony may no longer be deducted from the payor spouse and the payee spouse may no longer include the payment as part of his or her gross income.[21] The Section 11051 amendments apply to any divorce or separation instrument that was: (1) executed after December 31, 2018; or (2) “executed on or before such date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification.”[22] The IRC defines a “divorce or separation instrument” as “(a) a decree of divorce or separate maintenance or a written instrument incident to such a decree, (b) a written separation agreement, or (c) a decree (not described in subparagraph (a)) requiring a spouse to make payments for the support or maintenance of the other spouse.”[23]

Accordingly, any divorce decree, separation agreement, or other decree that addresses spousal support will continue to be tax deductible to the payor, and taxable to the payee, so long as the instrument was executed on or before December 31, 2018.[24] This means that, for example, spousal support will remain tax deductible to the payor unless the modification affirmatively states that the repeal applies.

 

Special thanks to Mallory Brennan for editorial, research, and writing assistance.

 

[1] 2017 Bill Tracking H.R. 1.

[2] IRC § 1041(a)(2).

[3] IRC § 1041(c).

[4] See generally Va. Code § 58.1-332.2 (defining “income tax”); Rabkin & Johnson, Current Legal Forms with Tax Analysis, Joint Income Tax Return § 10.21 (discussing the options available for a married individual’s tax return status).

 

 

H. Van Smith
Trusted Virginia Family Law Attorney Serving Richmond to Williamsburg