Divorce and the 2017 Tax Law: Spousal Maintenance, Business Valuations, and Child Support
The federal Tax Cuts and Jobs Act, which was passed in December
2017, impacts divorce cases in three major areas: spousal maintenance, business valuations, and the allocation of the child dependent exemption in child support matters.
Perhaps the Act’s most impactful change with respect to
family law is the reversal of the taxability of spousal maintenance payments.
Much has already been written on this topic, and I will leave the comparison
calculations to the CPAs.
For settlements and court decisions entered before
December 31, 2018, spousal maintenance payments are deductible from the
payor’s income and taxable income to the recipient.
For settlements and court decisions entered on or after
January 1, 2019, the reverse is true: Spousal maintenance payments will no
longer be deductible to the payor and will not constitute taxable income to
How this will affect settlement negotiations and trials
remains to be seen. One significant benefit of the change will be eliminating
the need to tax-effect, or “gross up,” the spousal maintenance payments.
Under current law, if the parties agree or the court
determines that the recipient’s reasonable needs are $5,000 per month, the
recipient must net $5,000 per month. Since the payments are taxable
income to the recipient, the payments must be “grossed up” to cover the taxes,
probably to $6,000 to $7,500. This requires the parties to make an educated
guess about the recipient’s effective tax rate, which may not always be
accurate. Alternatively, the parties may need to engage a tax expert to
calculate the recipient’s effective tax rate, which requires an examination of
all of the recipient’s sources of income. This may not always be possible, such
as in cases where the recipient spouse is rejoining the work force and does not
yet have certain employment.
Under the new law, the need to tax-effect the payment is
eliminated. If the recipient’s reasonable needs are $5,000 per month, then this
is the amount that should be ordered by the court (assuming the payor’s ability
to pay this amount). Thus, the new tax law simplifies matters by eliminating the
guesswork and necessity of a tax expert to tax-effect the spousal maintenance
Business Valuations in Divorce
The consensus among many business valuation experts is that,
in the absence of other changes in the business, the new tax law will increase
the value of businesses in divorce cases. This means that the spouse who keeps
the business will have to pay more to buy out the other spouse.
For valuations of operating businesses relying primarily on
the income approach (e.g., professional practices, retail operations, and some
manufacturers and wholesalers), the Act’s flat corporate tax rate of 21%, the
lower individual income tax brackets, and the availability of the Qualified
Business Income deduction mean potentially more cash flow available to the
business owner. More cash flow to capitalize means a higher present value
Under the market approach, the new lower tax rate could
render comparable previous sales as no longer truly comparable. Sales completed
under the old tax law would likely be undervalued compared with future sales
under the new lower tax rate.
For valuations utilizing the asset approach, the new tax law
appears to be the least impactful. For instance, the value of a company that
simply owns real estate or a non-occupied commercial structure is based on the
appraised value of the hard assets, rather than capitalized income, and is thus
largely unaffected by the new tax law.
Special thanks to Melissa E. Loughlin-Sines of Henry & Horne
for her critique and insight for the above section.
Child Support and the Dependent Exemption
Under Arizona law, when the court enters a child support
order, the court is also required to assign the right to claim the dependent
exemption for each child on the parent’s income tax returns. This is valuable to
the parents: For tax year 2017, each exemption was worth a $4,050 deduction from
the parent’s gross income.
Starting with tax year 2018, the new tax law eliminates all
personal exemptions. There remains the issue of which parent can claim each
child as a dependent, but the associated exemption (deduction from
gross income) is eliminated. The Arizona Child Support Guidelines specifically
refer to the “dependent exemption” and require the exemptions to be allocated
proportionately between the parents, based on their respective share of the
combined gross income. Presumably, the same rules apply to the allocation of the
right to claim each child as a dependent, not just the associated
exemption, but it appears the Guidelines will need revised language.
The importance of allocating the right to claim each child
as a dependent, for divorce purposes, now relates solely to the right to claim
the child tax credit (CTC). The CTC is also valuable to the parents, as it is a
straight $2,000 deduction from the tax owed. This amount begins to phase out at
an income of $200,000 for a single filer ($400,000 for married filers).
Additionally, while a child may be claimed as a dependent past age 18 if certain
conditions are met, the CTC applies only to a child who will be 16 years old or
younger on December 31st of the tax year in which the credit is claimed.
For settlements and court orders, the dependent exemption
should be allocated between the parties for tax year 2017, and the right to
claim the child as a dependent (and the associated CTC) should be allocated
between the parents for tax year 2018 through each child’s 17th birthday. In
addition to specifying this allocation in the divorce decree, the parties should
simultaneously execute IRS Form 8332 to formally transfer the right to claim
each child as a dependent for all future years.