Marriage and Divorce Under The Tax Cuts and Jobs Act of 2017

Share:

As a former practicing CPA, who is now a professional mediator, I pose the following question:  What has TCJA done to help couples improve the statistics regarding the institution of marriage and make the emotional issues of divorce less stressful?  I have not done any empirical research on either and my discussions with colleagues that handle divorce mediation have indicated that business has not been reduced. So I suppose the answer is that Washington has only created more work for the professionals who are intricately involved in helping couples sort out their issues in the hope of arriving at an acceptable, negotiated separation.  The purpose of this article is to highlight those topics that should be included when dealing in this area.  Since we are now into 2019 I will not focus on TCJA as it affects 2018 divorces other than to say if you were finally divorced or separated on or before December 31, 2018 alimony payments may still be made and are deductible by the payer and income to the recipient.  This rule is effective unless the agreement stipulates that the new law will apply.

Before getting into specifics of the new law there are some administrative steps that should be reviewed by the attorneys because they may raise other issues that go beyond the scope of this article.  They could lead to other causes of action that would take the couples out of the area of divorce and into criminality issues.  While women are now rising to positions of leadership in their chosen professions, and generating significant income, for this article I will assume, unless otherwise stated, that the Husband is the primary income earner.  When a couple decides to divorce one of them, generally the non-working spouse, gets a new attorney.  It is not infrequent that when the new attorney asks for copies of tax returns the spouse has commented that “I never signed a tax return nor do I have copies of them.  My husband handled it all with his accountant.”  Another comment that has sometimes been attributed to the spouse is, “He never filed a tax return nor does he pay taxes.”  Obviously this is a tough way to begin a new professional relationship with a client but let’s review what steps can be taken to overcome these potential problems.  {Note:  If a spouse makes a comment regarding never filing or paying taxes you, the professional, should ask why she had not filed a separate return using her own information so that she would not be part of this particular problem.}

Engagement Letter and Tax Return Filing Authorization: 

While it is not a required standard to obtain an engagement letter from a client for preparation of an individual tax return, it has become a best practices recommendation.  Generally the letter is issued to the couple, sets forth the nature of the engagement, how the fees are determined, the documents that the couple are to provide, and other matters relating to the preparation of the report, the retention of the documentation, and what services are not covered by the engagement letter (e.g. a subsequent tax audit).   The letter requests that both of them sign, date and return the letter to the accountant before work commences.

Under the current tax law, federal and most states prefer that tax returns be electronically filed rather than paper filed.  This requirement has been in effect for a few years and the burden of e-filing returns has been an additional pressure to the accounting profession.  Before returns are filed the clients must sign, date and submit separate e-file authorization forms to the tax preparer which are then used as the basis for submitting the returns to the governmental agencies.  For those not wanting to electronically file returns there are signed forms that are submitted to the preparer (and may also be attached to the filed returns) in which the clients opt-out and choose to submit paper returns as in prior years.

In many accounting firms clients are instructed to whom or what department in the firm the engagement letter and authorizations should be directed and this person (or someone in the designated department) is charged with the responsibilities of seeing that the letters are properly signed and dated, recorded in the taxpayers’ file and notifies the tax preparer that all the paperwork was received so that the tax work can be prepared and the returns eventually released.  When the new attorney contacts the tax preparer for copies of the documents his client does not have, it may be the first time that the accountant will actually look at the file to review the engagement letter and tax authorizations.  While the accountant should also request an authorization from the spouse to release the tax returns, the preparer’s responsibilities with respect to the engagement have been fulfilled.  It may subsequently turn out that the Husband signed both names to the engagement letter, the e-file authorizations, or the opt-out forms.  However it is not the tax preparer’s function to do a handwriting analysis.  If the Husband did sign both names the legal situation then changes to an area beyond the scope of this article.

Non-Filing of Neither Tax Returns nor Payment of Income Taxes:

I classify non-filers into four categories:

1-The first group are individuals who do not file returns because they find the process of preparing their tax papers too overwhelming or too distasteful and would prefer to engage in activities that make them happy.  Stay away from people like this because you will not be able to collect a fee large enough to cover your time.

2- The second group covers the class that has their returns ready but may be invested in partnerships that have not issued K-1s either because they are being audited by the IRS, or are having disputes with their external accounting firm regarding one or more treatments of accounting or tax issues which must be resolved before the partnership return is filed and the K-1s are released.   I will not discuss this group other than to suggest you speak to your clients’ tax preparer and agree on a method of procedure.

3-The third group covers those who intentionally do not file tax returns and are facing potential criminal and civil penalties.  There is no statute of limitations where tax returns are not filed.

4-The fourth group covers those who earn significant income from their jobs, have large withholdings deducted from their salaries, may also pay estimated taxes and are savvy enough to know that eventually returns will be filed that will reflect overpayments that will be applied to future years.  With these people the trick is to beat the government and file the returns before files are opened by IRS and correspondence begins to mount. 

Those in category 4 are the ones that I have found cause the spouse to make the aforementioned comments regarding non-filing of tax returns or non-payment of taxes.  If there is a non-working spouse ask whether there is a joint checking account or separate checking accounts and what are the sources of  deposits into her account.  In all cases you would eventually want to see copies of all accounts and trace the deposited funds and disbursements in all of them.  However, if there is a joint checking account probably the Husband has been overseeing that account, funding that account and has been signing the significant payments from that account.  The same would apply to his separate checking account.  As to the spouse’s separate account it will probably be funded by transfers from the Husband, deposits of income from the spouse’s investments, and social security (if applicable).  Certainly, as the spouse’s advisor you will proceed to either have the Husband become current on all tax filings or consider having the spouse file separate returns. 

Having reviewed the initial administrative matters what impact has TCJA had on marriage and divorce? 

Pre-Nuptial Agreement:

People are marrying at older ages which means they are generating larger incomes and potentially more wealth before they stand at the altar for the “I do”.  It would seem prudent that a pre-nuptial now assumes a more important role in the pre-wedding planning.  I would suggest that one of the terms of the pre-nuptial be that each year a computation be made allocating each person’s share of the joint tax liability to determine which mate provided more of the withholdings/estimated tax payments to cover the joint liability and that a payment be made from one spouse to the other to cover his/her shortage.  It is a computation that the tax preparer can easily make when the returns are completed and it can be part of the documents submitted by the tax preparer to his clients to review before they sign the e-file authorizations.  That requirement will help overcome the problems discussed above by putting each of them on notice that an annual tax return filing must be made.  A pre-nuptial is used in first-time marriages, where each person is bringing significant assets to the union and it is easier to trace the respective sources of that wealth.  This agreement is also used in second marriages where each has wealth and the sources may not be as easily traceable (This is especially true if one of them inherited wealth due to a death of the prior spouse. Be sure the estate tax return of the decedent is available as a permanent record to the document.).  In the case of a second marriage the couple may elect to file separate tax returns even though it may be more costly in order not to go through the annual computation referred to above and that each one need only concern himself/herself with his/her assets.  This couple may also seek advice from their attorney before purchasing any substantive assets jointly.   

Alimony and Other Deductions:

The alimony deduction was repealed by TCJA and affects all final divorces after December 31, 2018.  As indicated above, any pre-December 31, 2018 final divorces or separation agreements that were modified subsequently carry the same results as the pre-December 31, 2018 agreements unless the modification stipulates that the new law will apply.  Both ex-spouses must agree to this modification.  It may not be done unilaterally by one of them.

The TCJA suspended the miscellaneous deductions subject to the 2-percent of adjusted gross income through the year 2025. There were allowable professional fees that could have been claimed in the past if incurred in connection with taxable alimony and divorce-planning.

A caveat regarding this section is that one must review the state laws as they impact alimony and certain other deductions under TCJA.  If the states have decoupled from TCJA there may be some tax planning and negotiating between the parties for whatever benefits may accrue to the family unit, similar to what was done under the old rules.

Business Valuations and Divorce:

Under the new law there has been a reduction in the corporate tax rate from 35 percent to 21 percent, addition of a new deduction of 20 percent for business pass-through entities and changes in the immediate deductibility of additions for equipment and fixed assets.  These changes mean that businesses will have more after-tax cash available for the owners to withdraw and will impact the valuation of the business entity and the possible negotiations for property settlement.  

Conclusion:

This article is not meant to be all-inclusive but to highlight some of the major considerations that are significant as divorces proceed under the current tax law.  I did not touch on areas like personal exemptions, which are suspended through the end of 2025, nor did I discuss child support, whose computation may change as a result of TCJA, or the computation of the child tax credit, which TCJA modified.  These areas will probably arise as the negotiations between the parties continue.  As the primary advisor in the negotiations make sure to have other knowledgeable professionals, experienced in these areas, available as part of your team to present the best case for your client.