Article Written by:
Rebekah Smith, CPA, CFF, CVA, MAFF
Director of Forensic and Dispute Advisory Services

I have been invited over the last year and a half to speak to the family law community (practitioners, judges, magistrates, really anyone who will listen) about how the Tax Cuts and Jobs Act impacts divorces. The biggest change for our industry, of course, is the significant change in the taxability of spousal support (it is now not deductible by the paying spouse nor included as income by the receiving spouse).

You may know that this was one of the few permanent changes in the bill and one of the only cash flow positive (meaning it costs the tax payers money) changes. Spousal support payments previously shifted income from a higher bracket individual to a lower bracket individual and that will not happen anymore; as a result the total tax paid by both the payor and payee will increase. Simply put, the tax law takes away a deduction from a higher tax bracket earner. I have been telling people that, in general, the family will be worse off because the family’s total, after tax income will be lower. And that is still true.

The bill also provided that if you were divorced under the “old” law, you stay under the old law unless the parties opt to be under the “new” law. And given that most families will be hurt under the new law, I was struggling to see a circumstance under which it made sense to change to the new law. However, after a discussion during my presentation to a group of magistrates last week, I think we identified an interesting scenario where it might be better!

Have you heard of the Earned Income Credit (“EIC”)? The EIC is a benefit for working people with low to moderate income. It is a refundable tax credit (meaning a tax payer can receive a credit larger than their tax liability) for taxpayers who make below certain thresholds and meet other qualifications. Because of the new ability to make spousal support nontaxable, you could conceivably have a situation where a tax payer could be paid considerable spousal support, have little to no other earned income, and receive the EIC. Let’s take a look at the EIC thresholds and a hypothetical example.

Earned Income Credit 2019

To qualify for the EIC in 2019, earned income and Adjusted Gross Income (AGI) must each be less than the amounts in the following table:

Earned Income Credit - Ohio CPA Firm

There is an additional consideration in the limitation which is the individual cannot have investment income that exceeds $3,600. That would mean interest, dividends, capital gains, pass through investment income, etc.

The maximum credit amounts for 2019 are:

  • $6,557 with three or more qualifying children
  • $5,828 with two qualifying children
  • $3,526 with one qualifying child
  • $529 with no qualifying children

Consider a situation where the spousal support recipient files as a head of household taxpayer, has a part-time job earning $12,000 a year, has two children and receives $50,000 of spousal support. Previously, this taxpayer had $62,000 of taxable income ($12,000 plus $50,000). Under the new law, they would have $12,000 of earned income and likely qualify for the EIC. If electing to be treated under the new law reduces the spousal support recipient’s income below the EIC thresholds it might make sense for the family to elect to be treated under the new law, depending on the tax bracket of the spousal support payor who would be losing a deduction for the spousal support paid.

To learn more about the Earned Income Credit visit https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eitc-earned-income-tax-credit-questions-and-answers

 

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