An overview of the new tax law
The Tax Reform Act of 2018 has limited the amount a taxpayer can deduct as itemized deductions on the federal tax return. Married couples are allowed up to $24,000 in itemized deductions. Taxpayers who have a filing status of single are allowed up to $12,000.
The state and local tax deduction (SALT) has historically been the largest or second largest deduction claimed on Schedule A. The next itemized deduction that comes in either first or second place, depending on the size of the mortgage outstanding, was historically the mortgage interest deduction. Other popular itemized deductions on Schedule A were as follows: medical expenses which had to exceed the 7.5% or 10% AGI threshold before providing a financial benefit, charitable contributions subject to other thresholds and lastly what is commonly referred to as “other deductions” that had to exceed the 2% AGI floor.
Prior to this newly enacted tax law, a taxpayer who itemized deductions and was not subject to an alternative minimum tax (AMT) was allowed to deduct the state taxes & real estate taxes incurred and paid throughout the year on Schedule A. Assuming a taxpayer was not subject to AMT, if the resident state (or states that had nexus) imposed a high state tax rate and the taxpayer generated a reasonably high taxable income she or he would obtain a sizable tax benefit on their federal income tax return. In other words, if a couple generated say $300,000 in taxable income and was subject to a 6% state tax rate the couple was able to deduct $18,000 in state taxes on their federal return. If their real estate taxes were $20,000 they would receive a total benefit of $38,000 ($20,000 plus $18,000) in SALT deductions on Schedule A.
With this newly enacted tax law, Congress limited the SALT deduction to $10,000. Said differently $28,000 ($38,000 less $10,000) of former tax deductions that were available to the taxpayer is no longer available as a tax deduction for all future years. If the couple was in the 30% federal tax bracket, the taxpayers would have to pay an additional $8,400 in federal taxes going forward.
It is worthy to note, the $10,000 SALT limitation may be even further limited (depending on how you look at it) based on the $24,000 total itemized deduction available. In other words, if the mortgage interest exceeded $14,000 then either the mortgage interest or SALT deduction was automatically limited so the total itemized deduction would not exceed $24,000 for a married couple.
On the surface, without further analysis, the new tax law that imposes a SALT deduction appears to favor taxpayers who are not married (or no longer married) and who do not have large SALT or mortgage interest deductions.
How does this new tax law impact parties going through a divorce?
When it comes to a divorce these issues have to be closely analyzed to optimize the tax code for the divorcing party’s benefit. In context to a divorce and this new tax law, some questions that arise are:
- How will each spouse’s tax liability be impacted as a result of the separation?
- Would one or both parties benefit tax-wise moving to another state? If so, which state is the best state to live in and why?
- Would nexus come into play if one or both parties moved?
- If multiple properties exist in a portfolio, how should the real estate be divided to optimize the real estate tax deduction available?
- Are there ways to legally take deductions on one or both taxpayers returns to optimize the available SALT deduction?
- What other ways exist to design the financial settlement structure to optimize the SALT deduction?
This new tax law will have a meaningful impact on future tax liabilities of divorcing parties.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.