Divorce attorney Jason V. Owens reviews how changes to child tax benefits under the Tax Cuts & Jobs Act (TCJA) may impact divorced, separated and unmarried parents.

With 2019 around the corner, tax experts are scrambling to understand the full impact of the 2018 Tax Cuts & Jobs Act on taxpayers, including divorced and separated parents. The CPA Journal has gone so far as to dedicate an entire page to “TCJA Impacts”. For divorce professionals, the TCJA presents a dizzying array of issues, from the loss of tax deductibility of alimony, to questions about capital gains and itemized deductions.

One area of great concern to divorce professionals is the impact of the TCJA on child tax exemptions and child tax credits, which have historically provided significant financial benefits for parents. Under the prior tax law, a parent could claim a child as a dependent and reap the benefit of the child tax exemptions and/or credits. These benefits were generally available to non-custodial parents, as well as custodial parents, so long as the custodial parent executed an IRS Tax Form 8332, allowing for the transfer of the child tax benefits to the non-custodial parent.

Starting in tax year 2018, the TCJA eliminates dependency exemptions – including the child dependency exemption. However, the new law dramatically increases the standard deduction for individuals, single parents who can claim head of household, and married individuals. The TCJA also doubles the child tax credit, and according to TurboTax, the TCJA still allows non-custodial parents to claim the child tax credit, so long as the custodial parent executes IRS Form 8332.

In the blog, we review coverage of the TCJA’s impact on parents, with links to information provided by financial and tech media, tax software providers such as TurboLaw, and CPAs and professional groups. It’s important to note that many of the sources include educated guesses and elements of speculation, given that many tax professionals say that we won’t be sure how the final impact of the TCJA until tax season is fully underway in early 2019.

Child Dependency Exemptions Gone, Standard Deductions Increased, and Non-Custodial Parents Lose Ground

Under the old law, parents would receive a tax deduction of $4050 for each dependent child in their household. The TCJA eliminates these dependency deductions, but the law makes up for this loss of tax savings with a huge increase in the “standard deduction” for taxpayers. However, for non-custodial parents who claimed the child tax dependency exemptions, the TJCA reduces the tax benefit.

The combination of the standard deduction and the child dependency exemption ($4050/per child) provided substantial benefits for parents under the old law. Below we review how it worked.

Under the old law, the standard deductions were as follows:

• $13,000 – Married Filing Joint or Surviving Spouse

• $9,550 – Head of Household

• $6,500 – Married Filing Separate or Single filer*

*typical filing status for non-custodial parent claiming child dependency exemptions

Under the old law, a married couple with two children would receive a total tax deduction of $21,100 - by combining the standard deduction of $13,000 plus two child dependency exemptions totaling $8100. In essence, this meant that the family could keep the first $21,100 in income that was earned each year, tax free.

The old law also provided extra benefits for custodial parents who qualified for “Head of Household” status. Several factors allow a parent to claim head of household status, but for the purposes of this blog, we will focus on the following factor: to claim head of household, the dependent child must live with the parent for the majority of the year. As discussed above and below, custodial parents could transfer the child dependency exemptions to the non-custodial parent by executing IRS Form 8332. However, even if the custodial parent transferred the dependency exemptions, the custodial parent would retain the “head of household” status. Under the old law, the standard deduction for parents filing with head of household was $9,550.

Under the old law, most non-custodial parents who claimed the child tax exemptions in a given year would file as either “Married Filing Separate” or “Single” status, resulting in a standard deduction of $6500. (If the parent re-married, or had primary custody of other children, he or she would not need to file as “Single”.)

The TCJA makes up for the elimination of child dependency deductions with a big increase in the standard deduction. Under the TCJA, the new standard deductions for 2018-2025 will be:

• $24,000 for Married Filing Joint or Surviving Spouse

• $18,000 for Head of Household

• $12,000 for Married Filing Separate or any Single filer

For married parents with two children, the increased standard deduction is a net benefit, even with dependency exemptions eliminated. For a parent of two claiming head of household, the change has very little effect. For a non-custodial parent claiming two children, the change results in a net loss.

Comparison: total deduction for two children, old law vs. TCJA

As the table shows, married parents of two children receive a significantly larger total deduction under the TCJA, single non-custodial parents receive a significantly smaller total deduction, and a custodial parent of two children claiming head of household receives about the same deduction.

Dependency Deductions Eliminated under TCJA, but Child Tax Credits are Doubled

As noted above, the elimination of dependency deductions do not harm a typical married family of four, where the increased standard deduction under the TCJA is greater than the lost dependency exemptions. The TCJA also makes changes to child tax credits, doubling the amount of the credit for children under 17 years old and creating a new, smaller credit for older children as follows:

For 2018-2025, the Tax Cuts and Jobs Act (TCJA) doubles the maximum child tax credit (CTC) from $1,000 to $2,000 per qualifying child. …. Next, the TCJA established a new credit of up to $500 for dependents who are not qualifying children (a qualifying child must be under age 17). Under prior law, no credit was allowed for dependent kids who were age 17 or older because they did not meet the definition of a qualified child.

Many parents are confused by the difference between child dependency exemptions/deductions and child tax credits. The difference between a tax credit and a tax deduction is fairly straight forward. A tax deduction makes income tax free. Thus, a taxpayer who receives a deduction of $1000 is able to avoid paying taxes on $1000 worth of income. If the taxpayer is in a 28% tax bracket, a tax deduction for $1000 means he or she avoids needing to pay $280 in taxes on the income of $1000.

In general, tax credits are better than tax deduction deduction. A tax credit of $1000 means the taxpayer saves $1000 worth of taxes. To recap: if a taxpayer falls in the 28% tax bracket, then a tax deduction of $1000 means the taxpayer saves $280 in taxes (i.e. 28% of $1000). If the same tax payer receives a tax credit of $1000, then he or she receives a tax savings of $1000. A savings of $1000 is better than a savings of $280, right? Again, tax credits are better than tax deductions.

Tax Credits Under Old vs. Tax Credits Under TCJA

Under the old law, parents claiming the child dependency exemption could also claim a child tax credit of $1000 per year. While the TJCA eliminates the child dependency exemption, it has doubled the child tax credit to $2000. The TCJA also expands the child tax credit in two important ways that I explore further below.

Before going any further, it’s important to cover the single biggest limitation of the child tax credit: the age of qualifying children. Under the TCJA, parents can only claim the $2000 per year child tax credit for children who are younger than 17 years old. For children aged 17 or older, the TCJA provides a much smaller tax credit of $500 per year.

Under the old law, child tax credits were also limited by the child’s age. However, child tax credits were worth less under the old law. More importantly, the old law allowed parents to continue claiming the child dependency deductions for college-aged children who were enrolled in school up to age 24. One major impact of the TCJA is that increases tax benefits for parents of children who are 16 years old and younger by doubling the child tax credit. By eliminating child dependency deductions, however, parents of college-age children will receive reduced tax benefits under the TCJA.

Comparing the Child Tax Benefits: Old Law vs. TCJA

Obviously, the TJCA includes far-reaching changes to the tax code that are not limited to the child-related tax breaks reviewed in this blog. For example, the TCJA’s changes to federal tax brackets are likely to have a greater impact on some taxpayers than the changes to child-related deductions and credits. Nevertheless, it is helpful to perform some comparisons between the TCJA and old tax law as a way of understanding how the TCJA is likely to impact different families.

In making comparisons between the current and past tax codes, it’s important to bear in mind the distinction between tax deductions and tax credits, which have different bottom line values for taxpayers.

For most taxpayers, the value of a $1.00 of tax credit is roughly equal to a $4.00 tax deduction.

Approximate Tax Savings for Parent with ONE Child Under 17: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

In the example above, the married parents of one child under 17 receives more than twice the approximate tax savings received by a single, non-custodial parents claiming one child under the TCJA.

Approximate Tax Savings for Parent with TWO Children Under 17: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

In this example, we see that parents with one child under 17 receive a bigger boost under the TCJA than parents with two children under 17. Again, we see that married parents receive approximately twice the increase that a single, non-custodial parent receives under TCJA.

Approximate Tax Savings for Parent with THREE Children Under 17: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

This example drives home the reality that most of the boost received by parents under the TCJA comes for the first child. Additional children don’t seem to result in additional tax savings under the TCJA.

Approximate Tax Savings for Parent with ONE Child Over 16: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

In our first example with one child over 16, we see that the married taxpayer’s savings under the TCJA has only shrunk from $2737 to $2237 after the only child turns 17. However, with a 17-year old child, the non-custodial parent only receives about one third of the benefit of the married parent under the TCJA.

Approximate Tax Savings for Parent with TWO Children Over 16: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

In this example, we see that parents of children over 16 see diminishing returns under the TCJA with each additional child over 16. For a non-custodial parent with two children over 16, the TJCA only offers an approximate tax benefit of $350 per year compared to the old law.

Approximate Tax Savings for Parent with THREE Children Over 16: TCJA vs. Old Law

^x Standard deduction + child dependent deduction of $4050 per child

^yFor comparison purposes, tax credits are “valued” at 400% of tax deductions

With three children over 16, the non-custodial parent actually pays more in taxes under the TCJA than the old law.

Which Parents Benefit Most Under the TCJA?

Again, the tables above only provide rough outlines of the child-related tax benefits provided by the TCJA. However, the trend lines seem clear enough for us to offer some observations. What is clear is that the TCJA appears to offer at least some tax savings for parents compared to the old law. However, these savings are not evenly distributed. Here’s what we can say:

1. Most of the tax savings for parents are for the first child. For married parents of a single child, the TCJA offers some serious bang for the buck, with approximate tax savings of $2737 compared to the old law. However, additional children don’t seem result in greater tax savings under the TCJA. Instead, the TCJA appears to yield a significant tax benefit for the first child, before largely following the prior tax law for additional children.

2. Non-Custodial Parents Receive Smaller Gains Under TCJA. The biggest beneficiaries of the TCJA are married parents and custodial parents who can claim head of household. As noted above, it is not uncommon for a custodial parent to assign the tax benefits for a child to the non-custodial parent in a given year. It is still possible for a non-custodial parent to claim the child tax credits under the TCJA. However, filling status matters a lot under the TCJA. Non-custodial parents who have not remarried or do not otherwise qualify for head of household status still receive some tax savings under the TCJA, but it is substantially smaller than the benefits enjoyed by married and head of household filers.

3. TJCA Offers Less Benefits for Children 17 and Older. For parents of college-aged children, the TCJA offers diminishing returns, where the TCJA shifts the tax benefits for parents away from dependency deductions (which continued to age 24 for full time college students) to child tax credits, which are only fully available to children under 17 years old.

To be clear, parents of children over 16 will receive a noticeable tax benefit in 2018. After 2018 has come and gone, however, the benefit will fade quickly. Indeed, in future years, parents are more likely to notice an increase in their tax bills as their children turn 17. With college costs looming, many parents may find this a bitter pill to swallow, given the massive size of the TJCA tax cut overall.

Other Important Details About Child Tax Credits Under TCJA

As noted above, child tax credits double from $1000 to $2000 for children under 17 under the TCJA. The TCJA also provides a $500 dependency credit for children 17 and older (as well as grandparents and other dependent relatives) that was not available under the old law. Two additional changes to the tax credits are worth mentioning. The first affects high-income parents and the second impacts very low-income parents.

A. New Tax Credits Favor Higher Income Taxpayers by Eliminating Caps

Under the old tax law, child tax credits got smaller and smaller for parents who earned greater income:

The beginning phase-out limit for married taxpayers filing jointly was just $110,000 in 2017. It was a mere $55,000 for married taxpayers who filed separately, and $75,000 for all other taxpayers.

In short, the old child tax credit was mostly geared towards taxpayers who earned less than $100,000 per year. In addition to doubling the credit, the TCJA dramatically increases how much a parent can earn and still claim the credit:

As of 2018, the phase-out begins for married taxpayers at a pretty significant $400,000. They can earn this much without losing any of their Child Tax Credit. The phase-out begins for all other taxpayers at $200,000. Each $1,000 earned over these amounts reduces the Child Tax Credit by $50. These phase-outs apply to the Family Credit as well.

It is important to note that the comparison tables above all assumed that a parent could claim the full child tax credit under the old tax law. However, many wealthier parents were unable to make use of the child tax credit under the old law due to their earnings. The TCJA essentially quadruples the income caps for the child tax credits. This means that wealthier parents – who now qualify for the child tax credit – will receive greater benefits under the TCJA.

B. Tax Credits Now Refundable, Even for Parents Who Don’t Owe Taxes

Child tax credits under the TCJA also include a strong benefit for low-income parents. Under the old law, the child tax credit could only be used by parents who actually owed taxes. What does this mean? Well, to put in context, a single mother who could claim head of household under the old law received a standard deduction of $9,550, as well as child tax deductions of $4050 per child. Thus, a working single mother of two children would not pay taxes on the first $17,650 she earned in a given year. Under the old law, the child tax credit was essentially useless to the same mother, unless she earned greater than $17,650.

Under the old tax law, a parent could only apply the child tax credit to taxes owed. If the parent did not owe taxes, the credit was useless. More precisely, a parent could not use the credit under the old law to increase his or her tax refund if that parent didn’t owe taxes.

The TCJA now allows working parents to receive as much as $1400 of the child tax credit as a refund, even if that parent did not owe any taxes. It’s important to understand that the tax credit still has no real value to a parent who does not work at all. However, the TCJA now provides that once a parent earns more than $2500 in a given year, the parent may receive a partial refund for the tax credit – even if the parent does not owe any taxes. A parent who earns around $13,000 per year – but owes no taxes – should receive a refund of $1400 based on the tax credit.

For low income working parents, the ability to claim the credit for a partial refund will result in an important financial benefit that was not available under the prior law. When combined with the major increase in standard deductions, many parents who earn less than $25,000 per year are likely to see a substantial tax savings and increased tax refunds.

C. $2000 Credit Only Applies to Children 16 Years Old or Younger

One major impact under the TCJA is that the $2000 per year tax credit is only available for “qualifying children”, who are defined under the law as younger than 17. For dependent children older than 17, a separate tax credit of $500 per year is available. Interestingly, the $500 per year tax credit available for dependents is not limited to children aged 17 or greater. The new $500/year credit also applies to other relatives and adult dependents, such as grandparents, who live with the taxpayer and are dependent on the taxpayer for at least 50% of their annual income. (This article provides a good rundown of how edibility for adult dependents.)

TCJA Better for Most Families with Younger Children Due to Increased Child Tax Credit

One area of persistent confusion surrounding child-related tax benefits is the difference between child dependency exemptions and child tax credits. As noted above, the TCJA eliminates child dependency exemptions. Under the old law, parents would receive a deduction of $4000 per dependent child, as well as a $1000 tax credit for each qualifying child. In comparison, the TCJA provides a $2000 tax credit for each child. Which is better?

In general, tax credits are far better than tax exemptions. A tax exemption of $4000 simply reduces your taxable income by this amount. Thus, instead of paying taxes on $20,000 per year in income, you’d pay taxes on $16,000 per year in income after applying the exemption. But remember, you would only pay taxes on a fraction of that $4,000. Indeed, under the 2017 tax brackets, you would only pay income tax of 15% on that $4000 – i.e. $600 in taxes. Thus, the tax exemption of $4000 would save you $600 in taxes.

A tax credit is different. Using the same example above, a tax exemption for $4000 results in lower taxes of $600, while a tax a credit of $1000 results in a tax savings of…$1000. In other words, while a tax exemption lowers your taxable income, a tax credit reduces your taxes directly in the specific amount of the credit.

For many families, a tax credit of $2000 per child will generate a superior tax benefit compared to the mix of exemptions and smaller credits available under the older tax law. But there are big exceptions. And some of the hype about credits vs. exemptions are a little overblown.

TCJA: Higher Income Parents Can Receive Tax Credits

Another big change under the TJCA is a dramatic increase in the amount that families can earn and still receive the child tax credit. Under the old law, families earning more than $110,000 per year, and individual parents earning more than $55,000 were subject to “phase-out” under the child tax credit. Essentially, parents earning over these income caps received smaller and smaller credits, the more they earned.

The TCJA increases the phase out to $400,000 per year for families and $200,000 per year for individuals. Clearly, the increase in the phase out caps helps wealthier families. However, the benefit to wealthier families is somewhat overblown when you factor in the loss of tax exemptions these same families must absorb. It’s important to remember that as families and individuals earn more, their tax rates increase. For example, in 2017, families paid federal taxes at a rate of 28% for income over $208,350 per year.

Higher earnings families will now have access to the child tax credits, but this “gain” will be somewhat offset by the “loss” of no longer being able to claim the dependency exemptions of $4000 per year for each child. For wealthy families with multiple children over the age of 17, the TCJA is likely to result in a substantial tax increase.

Smaller Families Get Big Benefits Under TCJA, But Face Challenges as College Looms

Taxes are complicated. With this in mind, it is difficult to make blanket statements about which families will benefit vs. suffer under the TCJA. Here are a couple of important points to consider:

1. Under the TCJA, the “standard deduction” has increased from $12,000 per year for individuals to $24,000 for families. In comparison, under the old law, each taxpayer received a standard deduction/exemption for of $4,050 for themselves and each dependent.

2. This means that under the TCJA, a married couple without children gets the full exemption of $24,000. Under the old law, a family needed to have two parents and four children before their exemption reached $24,300 (i.e. $4050 x 6). In plain English, this means that smaller families receive tax exemptions under the TCJA that were only available to much larger families under the old law.

3. The tax credit of $2000 per child provides a different – and bigger – benefit to parents with more children under the TCJA. However, unlike child tax exemptions under the old law, the child tax credits under the TCJA are only available for children 16 years old or younger.

4. Parents with college-age children get the shorter end of the stick under the TCJA. Although the TCJA offers a tax credit of $500 per year for children who are 17 or older, this is only a fraction of the $2000 per year credit available for younger children.

5. A family of six, with four children 17 or older, will probably pay a similar amount of taxes under the TCJA compared to the old law. Indeed, they even pay slightly less, when the $500 per year credit is considered. However, this may not provide much solace for such families, when they compare their tax bills with those of much smaller families, or families with younger children, who receive far larger benefits under the TCJA.

6. The TCJA leaves in place many of the tax credits enjoyed by college students in the past. However, the loss of $1500 per year tax credits, as children turn 17, is likely to put the financial squeeze on parents whose children are approaching college age. Even if these parents’ overall tax liabilities are comparable or slightly better than the old tax law, the sudden loss of $1500 per child in tax credit is likely to sting for parents, who will suddenly face increased taxes at a time when college costs are looming.

TCJA Child Tax Credits Increases Refunds for Low Income Earners

In the context of child-related tax benefits, the big winners under the TCJA are smaller, wealthier families. However, the TCJA also provides clear benefits to lower income parents.

Under the old law, the $1000 per year child tax credit could only be applied to the taxes owed by a parent. A parent who did not owe taxes could not receive any portion of the credit as a refund. Under the TCJA, this changes: a parent with zero taxes owed can receive up to $1400 of the child credit as a refund under the TCJA.

In order to receive a portion of the credit as a refund, a parent must have earned income of at least $2500 per year. One a parent earns $2500 in a given year, however, he or she can start benefitting from the child tax credit – even if the parent does actually owe anything for taxes. In plain English, this means that even if a parent owes zero federal taxes, he or she can use a portion of the child tax credit to receive a refund, so long as the parent has earned at least $2500 for the year. (Specifically, a parent can receive 15% of any income they receive over $2500 as a refund, up to a total refund of $1400 per child.) In general, this means that a parent who earns between $2500 and $12,000 can receive a refund of up to $1400 per child, even if that parent does not owe taxes.

TCJA Impact for Divorced Parents, Divorcing Parents and Unmarried Parents

The child-related tax benefits under the TCJA impact divorced, divorcing and unmarried parents in a variety of ways:

1. Tax benefits still transferable to non-custodial parents. As noted above, the TCJA still allows custodial parents to transfer the child-related tax benefits to non-custodial parents by executing IRS Form 8332.

2. TCJA tax benefits greater for married and head of household parents. Although most parents receive at least some tax benefit under TCJA, parents who can filed as married or head of household receive significantly greater benefits than parents who are married filing separately or filing singly.

3. Parents can “spread the wealth” by each claiming one child. As noted above, the majority of tax savings for parents under the TCJA are received for the first child claimed. Claiming additional children certainly results in additional tax savings, but the first child is simply worth more under the TCJA. For separated parents with several children, it may make economic sense to ensure that each working parent claims at least one child each year whenever possible.

4. When children turn 17, parents will face tax increases. The TCJA provides substantially greater benefits to parents with children under 16. For 2018, parents with children over 16 will likely notice a reduction in their tax bill. In 2019 and future years, however, most parents will notice their tax bills going up as children turn 17. This will likely add to the difficulty parents already face paying for college.

5. Wealthy parents do better under TJCA. Because the TCJA drastically increases the income levels at which parents can claim child tax credits, the new law will result in major tax savings for parents who previously earned too much to claim the credit.

6. Low-income parents will receive greater refunds under TCJA. Under the old law, working parents could not take advantage of child tax credits unless they owed taxes. The TCJA allows low-income working parents to receive most of the child tax credit as a refund, even if they don’t owe taxes.

Many questions remain about the broader impact of the TCJA on families. The TJCA still allows individuals and couples to deduct mortgage interest from their taxable income (albeit at somewhat lower levels), but caps the deductions on state, local and real estate taxes at $10,000 per year for married couples (and $5,000 individually). For many Massachusetts families, the cap on these tax deductions will limit or much of the benefit under the TCJA. In particular, homeowners paying significant real estate and state income taxes may suffer under the law, while high earners in regions that collect significant state income taxes – like Massachusetts and New York – might find themselves disappointed by the TCJA’s much touted benefits. (Ironically, it seems that wealthy individuals and real estate developers who rent out investment properties can continue to deduct all of their mortgage interest and property taxes as “rental expenses” under the TCJA, as well as a “phantom” deductions such as depreciation, despite the new limits on deductions for ordinary homeowners under the TCJA.)

For divorce professionals, it will probably take a couple of years before the nuances of the TJCA become clear. The potential tax advantages discussed in this blog will remain highly theoretical until tested on actual tax filings with the IRS. Indeed, we probably won’t know the real details of how the TJCA works until the upcoming tax season has come and gone. Moreover, questions such as how parents should apportion tax credits for children over 17 are likely to remain somewhat ambiguous until attorneys, judges and litigants have experimented with different scenarios to the determine the advantages and disadvantages.

Important Disclaimer: Nothing in this blog should be construed as tax, legal or accounting advice. This blog has been prepared for educational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction or tax filing.

About the Author: Jason V. Owens is a Massachusetts divorce lawyer and Cape Cod family law attorney for Lynch & Owens, located in Hingham, Massachusetts and East Sandwich, Massachusetts.

Schedule a consultation with Jason V. Owens today at (781) 253-2049 or send him an email.