May/June 2018 Tax Tips

Alimony deduction is coming to an end

The Tax Cuts and Jobs Act (TCJA) eliminates the tax deduction for qualified alimony payments, effective for divorce decrees or separation agreements issued or executed after December 31, 2018. It won’t affect existing arrangements or arrangements finalized before the end of 2018.

Currently, alimony payments are deductible by the payer and included in the recipient’s taxable income. This makes it possible to shift income from the payer, who is typically in a higher tax bracket, to the recipient, who is usually in a lower tax bracket. Once the deduction is eliminated, payments will no longer be deductible by the payer or taxable to the recipient.

These changes provide divorcing couples with an incentive to finalize their proceedings by the end of this year. Some alimony recipients may be tempted to delay their divorces until next year, when the payments are no longer taxable. But the deduction can be advantageous to both parties, because it minimizes their combined income tax, making more after-tax income available for division.

Beware the “kiddie” tax

At one time years ago, parents could substantially reduce their families’ overall tax burden by shifting income to children in lower tax brackets (usually by transferring investments or other income-producing assets). The kiddie tax was designed to discourage this strategy by taxing most of a dependent child’s unearned income at the parents’ marginal rate. The tax applies to children age 18 or younger plus full-time students age 19 to 23 (with certain exceptions).

Under the TCJA, the kiddie tax is imposed according to the rates applied to trust income. The trust tax brackets are compressed, so that the highest marginal rate (currently 37%) kicks in when taxable income exceeds $12,500. In contrast, for a married couple filing jointly, the top bracket begins at $600,000 of taxable income. The impact of this change will depend on a family’s particular circumstances. In general, it will reduce the cost of the kiddie tax for relatively small amounts of unearned income, but many families will find that the top kiddie tax rate is now higher than the parents’ marginal rate.

Small businesses: Consider an HRA

Under legislation passed in late 2016, qualifying small businesses (those with fewer than 50 full-time or full-time-equivalent employees) are permitted to use Health Reimbursement Arrangements (HRAs) without running afoul of the Affordable Care Act. A cost-effective alternative to group health insurance, HRAs are employer-funded plans that use pretax dollars to reimburse employees for out-of-pocket medical expenses and individual health insurance premiums.

Late last year, the IRS issued Notice 2017-67, providing guidance on the eligibility requirements and tax implications of these Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs). Among other things, reimbursements from QSEHRAs are nontaxable to employees provided they maintain “minimum essential coverage.”

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