There are many reasons to get a divorce. Getting a break on your taxes due to the benefits attached to divorce is usually not at the top of anyone's list. I have been working with families going through a divorce for quite some time, and I have not heard one single person tell me that their primary motivator to getting a divorce was to take advantage of the tax benefits of doing so. Go figure.
We all know that getting a divorce is not fun. It is a stressful time that often involves moving out of the family home, getting a new place to live, and adjusting to living life on a single income are just a few of the transitionary elements to going through a divorce in Texas. If you are fortunate enough to be a parent, you are undoubtedly concerned about the transitions inherent in raising a child during and after a divorce. How is your child going to respond to the case and its changes? Will your relationship with your child suffer as a result of the divorce? Will you be able to co-parent with your soon-to-be ex-spouse effectively?
There are also important financial considerations in getting a divorce. The community property laws in Texas and the prospect of paying spousal maintenance after a divorce are frequently concerned people like yourself have as they get involved in the divorce process. You may have heard horror stories or hyperbole about either of these subjects and are now concerned about how your case will ultimately shake out. Are you going to be in a financial hole that you are unable to dig out from under?
Everyone's favorite subject, taxes, also plays a role in the divorce process. Due to the Winter Storm that we had in February of this year, Texans have an extended deadline to file and pay taxes for 2020 on June 15, 2021. This blog is not intended to act as tax advice. I am not a professional in the area of taxes. If you have any questions about tax law, federal income taxes, or a subject surrounding taxes, your best bet is to speak to a person in that field. Today's blog will focus on taxes and divorce but is not tax advice (or legal advice, for that matter).
Alimony and spousal maintenance- is it tax-deductible any longer?
In 2017, the Tax Cuts and Jobs Act was signed into federal law by President Trump. This law changed the tax code that may have significant impacts on your life and how your divorce will proceed through the settlement process. Most notably, alimony payments are no longer deductible on your federal income taxes. In Texas, there are two types of alimony: spousal maintenance as ordered through a divorce trial and contractual alimony negotiating between you and your spouse in mediation.
Depending on the length of your marriage, you may be in line to pay special maintenance for periods lasting anywhere from 5 to 10 years. The dollar value of the special maintenance every month can be no more than $5000 or 20% of your average monthly gross income. If you were not married to your spouse for at least 10 years, no spousal maintenance could likely be ordered in your circumstances.
On the other hand, contractual alimony is more of an agreement between you and your spouse created in mediation. The purpose of contractual alimony is a good faith effort to avoid going to court and solidify your agreements regarding the division of Community property and ensure both you and your spouse can provide for yourselves financially after the divorce.
Until the passage of this law in 2017, alimony and spousal maintenance in Texas were treated as deductions from your gross income if you were to be the spouse who was obligated to pay the alimony. Conversely, the spousal maintenance or alimony payments would have been treated as income by your ex-spouse. However, as of the beginning of 2019, alimony and spousal maintenance payments were no longer eligible for deductions. By the same token, your ex-spouse would no longer have to treat these spousal maintenance or alimony payments as taxable income.
As far as timing is concerned, the key thing is that if you entered into an agreement for contractual alimony or had a spousal maintenance order issued before 12/31/2018, then your orders are treated as being under the old set of laws. For many people going through a divorce, the change in the law that we have seen since 2018 could be seen as a reason not to get divorced or at least not to consider having spousal maintenance or alimony be a part of your divorce settlement.
The reason being is that if you were to pay spousal maintenance or alimony, then it is likely that you would be the spouse who earns more money and pays more in taxes as a single person. Therefore, the paying of spousal maintenance or alimony would be seen as a deduction that may cause you to jump down a bracket in taxes and save money where you are able in overall taxes each year. You may not mind paying a larger sum in alimony or maintenance if you can then write the money off on your taxes each year.
What about the child tax credit?
For many years, families like yours were able to take advantage of a dependency exemption which allowed you to make exemptions from your taxable income based on the number of children in your care. A child tax credit was also (and still is) a mainstay for families to incorporate into their tax planning for minor children. The Tax Cuts and Jobs Act allows you to take advantage of a per-child credit of $2,000, whereas the figure previously was only $1,000. More families are eligible to take advantage of these tax credits. The income threshold of doing so has risen dramatically both for single and joint filers due to this law coming into place.
If you are familiar with our blog here on the website of the Law Office of Bryan Fagan, then you know that in a divorce, there are typically two different types of parenting roles that you may take on after the divorce as far as conservatorship is concerned. The first is as a primary conservator who determines the children's primary residence, receives child support, and generally holds more exclusive or independent decision-making capabilities for the kids. The second conservatorship role is that of a possessory conservator who has visitation rights with the kids and holds many, though not all, of the same rights about the children as the primary conservator.
A question that many parents have about their post-divorce financial lives is whether or not the possessory conservator can take advantage of the tax benefits made available through being able to claim their children on their taxes to receive a credit for having done so. The dependency exemption that we discussed earlier can be applied to either your or your co-parent's tax return after a divorce. Many parents like you may be anticipating a negotiation session over which parent "gets" to claim the children on their taxes each year after the divorce.
What does be The IRS has to say about claiming children as dependents on your taxes?
HOWEVER, the IRS has issued guidance on this issue since the passage of the Tax Cuts and Jobs Act. To begin with, a child may be the dependent of only one parent- you or your ex-spouse- in any given tax year. This is an important distinction to make given that I have encountered some parents operating under the impression that each parent would be able to claim their child as a dependent on their yearly taxes.
Generally speaking, so says the IRS, your child will be the qualifying child (who allows you to take advantage of the child tax credit) as a dependent if they live with you primarily during the year. Therefore, applying that to Texas family law, whoever is the primary conservator of your child would be able to take advantage of the child tax credit. This is because your child would be living for a longer period during the year with that particular parent.
However, the noncustodial parent can be treated as the qualifying child if a special rule applies. This rule requires, in part, that both of these following conditions are met in your circumstances: that your Co-parent would have to sign a tax form that releases or revokes the ability to claim the child on their taxes as the custodial parent. Additionally, you would need to attach that form to your tax return. I can't say that I'm familiar with many families that have gone through this procedure, but it does seem simple enough to allow it to be done.
If your Co-parent, as the custodial parent of your child, releases a claim to file an exemption for that child, then you could claim your child as a dependent and receive the qualifying child tax credit. Keep in mind that, however, you as the noncustodial parent may not claim the child to be head of household, the earned income credit, or the credit for child and dependent care expenses. Instead of getting further into the weeds on tax issues, I would recommend you speak to an experienced tax professional about these types of subjects while you are going through a divorce and your family law attorney to receive better guidance based on your particular circumstances.
What about the taxes associated with selling your home and interest on mortgage payments?
A major area of financial concern for people that go through a divorce is their family home. Not only are people concerned with the idea of having to move out of their family residence and find a new place to live, transport their children back and forth between multiple residences and figure out how to sell a home if that is what is in everyone's best interest, but there are tax considerations to make in these areas as well.
Although many couples do their best to fight to keep the house in one of their possessions after the divorce, it may be in your family's interest to consider selling the house and splitting the equity in the home between you and your spouse. Doing so can result in capital gains taxes that need to be considered while you and your spouse work on a settlement together. The tax cuts and JOBS Act did not change the laws involving capital gains as much as they did regarding the laws on deductions and credits associated with your children.
For instance, if you have lived in your house before the divorce for at least two years and decide to sell the home, then you can exempt up to $250,000 of the gain on the sale from the house. If you are married filing jointly, that number doubles to $500,000 so long as either you or your spouse owned the residence and both would be resided in the home for at least two out of the past five years. By the same token, even if you are awarded the house in the divorce and choose not to sell, you may do so and still be able to exclude 250,000's worth of gain for capital gains purposes.
Do you own a home equity line of credit? This has become a much more popular method in recent years if you want to perform updates or improvements on the House or perform some action that you otherwise would not have been able to do but for this loan. Your home access is the collateral for the loan and, in many cases, is treated as a second mortgage by folks. The tax cuts and JOBS Act no longer allow people to deduct the interest paid on home equity lines of credit. However, an exception is made for home equity lines of credit used specifically to improve that home.
The most important issue that I can conceive of about you and your spouse who is going through a divorce is if one of you is ordered to pay the mortgage on the home and can then take the interest deduction on your taxes for having paid that mortgage. Before the tax cuts and JOBS Act came along, if you were ordered to pay all the mortgage payments on your Community property home, then you would be able to deduct half of the interest paid as mortgage interest and then deduct the other half of the interest paid as contractual alimony or spousal support. As we touched on earlier, however, alimony is no longer allowed as a deduction. Therefore, the mortgage payments made on your Community property home lose much of their tax benefit as a result.
A word on college savings plans for your children
Are you in the process of trying to help your child save for college expenses? As college expenses increase every year, it becomes more and more important for you to plan to pay for your college education. The benefit to saving outside of a checking or savings account is that compound interest can work its magic to help you truly get some bang for your Buck and let your dollars do the work for you well you attend to other matters.
Contributions into a 529 college savings plan are not deductible. However, the earnings within a 529 plan grow tax-free and will not be taxed when the money is taken out to pay for your child's college education. With the passage of the tax cuts and the job act, tuition for elementary, secondary, or religious high schools is all covered under this plan. Meaning that even if college is not in the plan for your child, a school that charges the funds can pay for tuition within this 529 plan.
Concerned about the tax ramifications and financial costs of divorce? Contact the Law Office of Bryan Fagan
it is normal to be concerned with the impacts of a divorce on your life, family, and finances. To go into a divorce without these concerns would be abnormal. However, by learning as much about the process as you can before filing for divorce, you can better prepare yourself and your family for what's to come. The best advice you can receive regarding planning for divorce is to meet with and eventually hire an attorney who is experienced in helping people, just like you manage everything that comes with a Texas divorce case.
If you have any questions about the materials shared with you in today's blog post, please do not hesitate to contact the Law Office of Bryan Fagan. Our licensed family law attorneys offer free of charge consultation six days a week in person, over the phone, and via video. These consultations are a great opportunity for you to learn more about the world of Texas family law and how your family circumstances may be impacted by the filing of a divorce or child custody case.