How the Tax Cuts and Jobs Act of 2017 Affects Divorce, 0618 COBJ, Vol. 47, No. 6 Pg. 26

• Author: SUZANNE GRIFFITHS, BORIS SOBOLEV, AND CHRISTOPHER GRIFFITHS, J.
• Position: Vol. 47, 6 [Page 26]

47 Colo.Law. 26

How the Tax Cuts and Jobs Act of 2017 Affects Divorce

Vol. 47, No. 6 [Page 26]

The Colorado Lawyer

June, 2018

FAMILY LAW

SUZANNE GRIFFITHS, BORIS SOBOLEV, AND CHRISTOPHER GRIFFITHS, J.

This article highlights recent changes to the Internal Revenue Code that affect Colorado divorce cases.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017¹ (the Act) was signed into law by President Trump. The Act represents one of the most significant overhauls to American tax law in more than 30 years; it significantly changes how individuals, businesses, tax-exempt organizations, and others are taxed. The Act affects every individual taxpayer, from wage earners to business owners, and all business entities.

Although the Act provides benefits for some, it is widely believed that a number of changes will make divorce more difficult and expensive. This article highlights recent tax code changes that affect the evaluation of various financial matters in divorce cases, particularly regarding maintenance. It is imperative that practitioners understand the 2017 changes to the federal tax law so that they can advocate effectively.

Calculating Maintenance

The most significant tax code change in the divorce context is that maintenance will no longer be tax deductible by the payor, effective for all divorces or separation instruments² executed after December 31, 2018. Instead, maintenance must be paid on an after-tax basis. This places a more significant overall tax burden on divorcing parties and makes the determination of appropriate maintenance more difficult.

Under prior law, because maintenance was tax deductible to the person paying maintenance, courts could calculate maintenance using a person's gross income. To assist judges in determining appropriate maintenance awards, in 2013 the Colorado General Assembly enacted a set of advisory maintenance guidelines.³ Under current law, courts are instructed to consider maintenance that is "equal to forty percent of the higher income party's monthly adjusted gross income less fifty percent of the lower income party's monthly adjusted gross income[.] "⁴ Gross income was used to determine a party's maintenance obligation because it is easier to calculate and predict than net income and the tax impact of maintenance payments for each spouse is fairly easy to determine using gross income. The payor-spouse would simply pay the maintenance amount and deduct the maintenance from his or her taxable income, and the payee-spouse would receive the maintenance as gross income and be taxed accordingly. When maintenance is not tax deductible, determining an "appropriate" amount of maintenance is no longer straightforward and cannot be based solely on consideration of a party's gross income, because each taxpayer has different circumstances that affect effective his or her taxrate.

When basing a maintenance award on net income, the maintenance amount has to account for the tax rate of the payor-spouse. The more tax that the payor-spouse pays, the less net income she has available to pay maintenance. As explained elsewhere in this article, under the Act, the source and type of income earned by an individual has an effect on that individual's net income. Accordingly, it may be reasonable for a payee-spouse who is married to a self-employed architect to receive more maintenance than a similarly situated payee-spouse who is married to a W-2 wage earner or a highly compensated attorney, even though the gross incomes of their respective payor-spouses are similar. To implement an equitable maintenance award, practitioners and courts must consider the effective taxrate of the spouse who pays maintenance so that spouse's net income can be properly determined. This is particularly challenging under the new tax code, as individuals and businesses are taxed at drastically different rates depending on what the individual does for a living or how the business is structured.

Colorado’s maintenance statute and child support guideline formula were designed assuming maintenance deductibility. In response to the Act, the Colorado General Assembly is currently considering HB 1385, which (1) adjusts downward the advisory guideline calculation of the maintenance amount where the maintenance awarded is not deductible by the payor-spouse and is not taxable income to the payee-spouse, (2) amends the definitions of “gross income” and “adjusted gross income” to properly reflect the tax implications of maintenance obligations, and (3) adjusts the definitions of “gross income” and “adjusted gross income” in calculating child support obligations to reflect the tax implications of maintenance obligations.⁵ The bill was introduced in the House on April 12, 2018 and was introduced into the Senate on April 27, 2018. Most practitioners expect the bill to pass in some form, as some changes are necessary to ensure that courts are adequately prepared to handle the new tax changes.

Individual Tax Brackets and Standard Deductions

The new tax legislation retains seven tax brackets, but the level of income at which each bracket applies and the respective percentage of tax has changed.⁶ The following chart indicates the old tax rates along with the new, modified tax rates:

2017 RATES	2018 RATES
10%	10%
15%	12%
25%	22%
28%	24%
33%	32%
35%	35%
39.6%	37%

The overall amount of tax owed by most taxpayers has dropped, because the marginal tax rates have decreased and the level of income at which each marginal tax rate is in effect has increased.⁷ Taking the highest income earners as an example, the marginal tax rate has decreased from 39.6% to 37%, and the income at which the highest marginal rate starts has increased from $426,700 to $500,000. Both of these changes affect how much tax an individual must pay, which in this case works to lower the top income earner’s taxable income and income tax. In addition to modifying the individual tax brackets, the new law increases the amount of the standard deduction for single individuals from $6,500 to $12,000, and for married couples from $13,000 to $24,000. However, the $4,000 per person personal exemption has been eliminated,⁸ so the marginal increase in the standard deduction, after accounting for the loss of exemptions, is only about $1,000 to $2,000 per tax return. For a head of household, the standard deduction has increased from $9,550 to $18,000.⁹ Under the Act, maximum savings for a person with head of household status compared to single fling status are now $3,500 instead of $5,000 under the old law. Itemized Deductions The Act changes the way many itemized deductions are treated. The most important effect of this change is that fewer taxpayers will itemize deductions. As explained above, the new standard deduction amount has almost doubled, so many taxpayers will be better of claiming the standard deduction rather than itemizing their deductions. An important change for higher income taxpayers is that itemized deductions will no longer be limited.¹⁰ Under the old law, itemized deductions were limited for single taxpayers earning over $258,250 and married taxpayers earning over $309,900. Mortgage Interest A common itemized deduction is mortgage interest. The Act limits the home mortgage interest deduction to indebtedness of an amount up to $750,000—meaning a taxpayer can only claim a deduction on mortgage interest associated with a mortgage of up to $750,000 in mortgage debt.^[11] The value of the home itself is irrelevant; what matters is the amount of the indebtedness. However, this provision does not apply to mortgages “incurred on or before December 15, 2017.” For many divorcing couples, the marital home is their most valuable asset. When negotiating a separation agreement, practitioners should consider the deductibility of mortgage interest in determining a party’s expected net income and how the deduction should be allocated. State and Local Tax Deductions Under the Act, individual and married taxpayers can deduct a total of only $10,000 in state and local taxes.^[12] The cap on state and local taxes (SALT) was contested in Congress because it has a disproportionate effect on taxpayers in each state. The more SALT taxes a taxpayer pays, the more the cap on this deduction affects the taxpayer. Taxpayers in states with low SALT taxes are primarily unaffected, whereas taxpayers in states with high SALT taxes will be required to pay much more federal tax than before. Practitioners should consider the amount of available SALT deductions for each party and their expected income after the divorce because the availability (or unavailability) of those deductions will affect each party’s net income and ability to meet expenses going forward. Child Tax Credit The Act raises the child tax credit from $1,000 to $2,000 and also increases the income limitation for married couples from $110,000 to $400,000.¹³ The maximum amount that is refundable is now $1,400.¹⁴ This credit phases out completely at $240,000 for single and $440,000 for married filers.¹⁵ The expansion of the child tax credit was the legislators’ way of attempting to compensate families with children for the loss of personal exemptions. For dependents who are not eligible children under the age of 17, there is a $500 non-refundable credit available, also referred to as a “family credit.”¹⁶ The child tax credit is a significant consideration when drafting a separation agreement because of its value to the party entitled to claim the credit on his or her taxes. By increasing t he income limitations, the new adjustments increase the number of divorcing persons who are...