Ever since the “Tax Cuts and Jobs Act” passed in Congress last December, there has been lots of talk about how it will affect the tax returns of individuals, corporations and other business entities. Who stands to gain and who stands to lose? But beyond the extensive analysis and speculation about tax status, relatively few observers have noticed that the new bill will affect other aspects of living and doing business as well. One of the most important of those areas is the unanticipated effect the law will have on divorce and child custody.
Much of the commentary on the effects of the tax law on divorce has focused on the treatment of alimony under the new law. The new law mandates that, for divorces finalized after Dec. 31, 2018, the spouse paying alimony will no longer be able to deduct those payments from his or her taxable income. And the recipient of alimony will no longer be required to pay taxes on the alimony payments.
This sounds like a win for the individual receiving alimony, but actually the law cancels out one of the prime motivators for the higher-earning spouse to agree to pay alimony in the first place—or may motivate him or her to fight for a lower payout. The spouse who would pay monthly support may even want to consider other means of compensating the spouse who would receive support, such as transferring other property or retirement benefits.
With regard to divorce in Texas, a much more serious issue is hiding behind the much-discussed concern about alimony. That issue is how the new tax law will affect business valuation.
The valuation of a private business as an asset is often the most bitterly contested issue in a divorce. The new law increases the cash flow of certain kinds of businesses due to the lower C corporation tax rate (reduced from 35 percent to 21 percent) and also as a result of the change in status of businesses in which the taxes on earnings are paid by the owner, not the company—pass-through arrangements—such as partnerships, limited liability companies, S corporations and sole proprietorships. Both provisions can increase the value of the business. But the exact amount of the increase in value, and whether it is significant or not, probably won’t be known until the business’ first tax return is filed under the new law.
The new law also allows 529 college savings plans to be used now to pay for private schools, not just post-secondary schools or college. This issue needs to be addressed as part of the divorce settlement, as well. It’s important to calculate how far these savings will stretch so that you don’t run out of money before your student even reaches college. A fund to pay for college may have to be negotiated separately.
The new law will affect other aspects of divorce. Personal exemptions have been suspended for the tax years beginning after Dec. 31, 2017, and ending Dec. 31, 2025. During this eight-year period, divorcing parents cannot use personal exemptions for dependent children and don’t need to negotiate which parent gets to use the exemption. They can negotiate which parent can claim the Child Tax Credit, but they should remember that whoever gets the Child Tax Credit will also receive the personal exemption starting again in 2026 (as of now).
Any other prior marital agreements, such as prenuptial and post-nuptial contracts, will also need to be re-examined in light of the effects of the new tax reform law.
In short, the primary concern for many spouses who are divorcing in Texas will be how the new laws concerning business entities will affect the valuation of a business or businesses. If you are contemplating divorce, this is probably one important concern you should mention to your attorney early in the process.
This article was prepared by Robert S. Hoffman, a board-certified family law attorney who has been practicing for 31 years in Houston, and by Jennie R. Smith, of counsel in the Law Office of Robert S. Hoffman.