Don’t Let the Tax Tail Wag the Divorce Dog
by Bonnie A. Sewell, CFP®, CDFA™, AIF®
Divorce is such a fun topic, now let’s go all in and add taxes to our chat—ouch! But as we near the end of 2018, there is a fair amount of impact with the new tax law, and you can’t do better for yourself if you don’t know better. This guest blog covers two of the bigger, more common concerns—alimony and the home.
Better to finalize in 2018 or 2019? You and your soon-to-be-ex must have a signed settlement or have your divorce finalized by December 31, 2018, in order to have spousal support (aka maintenance, alimony) treated under the current law, which has been in place for over 75 years. Under the current (but expiring) rules, alimony is deductible dollar for dollar on the front page of the 1040 for the person who pays it. Additionally, alimony is taxable as income on the front page of the 1040 to the person who receives it. If you wait until January 1, 2019, or later to sign your settlement or finalize your divorce, you will fall under the new rules, which treats alimony as tax neutral, just like child support. That is, the deduction for the person who pays alimony goes away and it is not taxable to the person who receives it.
It’s hard enough to decide if you want to keep your home in a divorce and now the rules have changed the math in important ways. All of us must choose whether to take the standard deduction or use Schedule A to deduct a higher amount. Let’s look at the details: A single taxpayer now has a standard deduction of $12,000 and a head of household has a standard deduction of $18,000. On Schedule A, where you can take SALT (state and local taxes) deductions, you are limited to $10,000 total for that entire section. In high-tax states, that amount is less than some property taxes alone. And it gets worse. Under the new rule you can deduct mortgage interest but only on a mortgage up to $750,000. The effective date of this change is any home purchased between December 14, 2017 (yes, 2017) and 2026. For the most part, home equity loan interest is no longer deductible unless it is used to buy, build, or substantially improve the taxpayer’s home.
You can still withdraw from qualified retirement accounts without penalty at the time of divorce, but the withdrawal amount is still taxable to the person who receives it. Withdrawals from retirement accounts can be an effective way to raise cash and sometimes people use this in lieu of alimony. *Be sure to work with a qualified divorce financial planner before attempting a withdrawal at the time of your divorce.
Taxes matter always and in divorce particularly, but a tax decision should be part of a larger decision, so make sure you are looking at the big picture before you adopt a tax strategy in divorce.
Bonnie A. Sewell, CFP®, CDFA™, AIF® is NOT AN ATTORNEY AND DOES NOT PROVIDE LEGAL ADVICE or TAX ADVICE. All information she provides is financial in nature and should not be construed or relied upon as legal or tax advice. Individuals seeking legal or tax advice should solicit the counsel of competent legal professionals knowledgeable about the divorce laws in their own geographical areas or CPAs qualified to provide tax advice.
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