Tax Law Changes & Itemized Deductions
The following is a transcript of an interview with Heidi Sherman and Jonathan Mishkin. In this interview, they discuss recent changes to tax laws and itemized deductions.
Heidi: Hi, I’m Heidi Sherman with Jill Brittle Family Law Group. And I have with me, Jonathan Mishkin, a tax attorney who manages his own law firm. Good morning, Jonathan.
Heidi: I wanted to ask you some kind of general questions about changes in the Tax Code that occurred last year or at the end of 2018. Are there changes to itemized deductions that occurred when they changed the Tax Code or the deductions that you could talk about?
Jonathan: Yeah, they basically, with the enactment of the TJCA at the end of 2018, the Tax Jobs and Cuts Act. And it applies starting in 2019, they took away the itemized deductions in the tax code, they replaced it with just a general, flat, exemptible amount. So, one of the I would say unanticipated consequences is that when people retain attorneys, and they spend sums of money with their attorney to recover something, they used to be able to take an itemized deduction for the payment of the attorney’s fees, they no longer can. So, one of the things I’ve warned a few attorneys is when you’re doing a settlement, and that clients paying you a share of the settlement, they’re not getting a deduction any longer, so they’re going to get even less money. After tax, I believe you need to bring that fact up with them, because I think they’re expecting a certain net. And they’re going to be extremely upset when it’s, you know, half of what they thought.
Heidi: So, are you are you saying that all the itemized deductions went away?
Jonathan: Pretty much all of the ones that you would be familiar with. And that what they tried to do quote, “simplify” the tax return by just giving you a flat exemption amount.
Heidi: So, is that the standard deduction that you’re talking about? And they’ve increased the standard deduction supposed to compensate for the loss?
Jonathan: Right, they’ve increased it three to four times what it used to be as their quote. I think what they their theory is, is that it reduces how much you have to record, keep and have proof. It’s like here, you can just take this instead and it’s not audible. A good comparison to that as when people take what’s called the standard mileage rate, instead of deducting their vehicle costs. The government just says 50 something cents per mile. Now, you don’t have to really track a whole lot other than proof that you went on that drive. But you don’t need your total receipts parking repairs. I think of it as very analogous. But it’s damaging, because it’s taking away money from people that are settling cases or spending significant attorney’s fees to resolve something.
Heidi: And so how about with regard to the division of assets in a divorce? Are there tax consequences to that?
Jonathan: There are not supposed to be any, there’s a section of the Code, section 1041, and which Oregon follows that says, division of assets between divorcing spouses, you know, this is incident to a divorce, it’s a tax-free separation. So, you just stepped into the shoes of the other spouse if you’re given an asset that was in that spouse’s name.
Heidi: So, for example, let’s say the parties jointly own a home, and as part of the settlement, one spouse is going to receive the home. You’re saying that’s a non-taxable transfer?
Jonathan: And that spouse would take over the basis of the other spouse, the cost basis of the other spouse. So, if the home was sold in the future, the gains spread would be preserved. Although if it’s your primary residence, you get an exemption from capital gains. Let’s say it was a rental property, you would then have a bigger capital gain. Because if you took your ex-spouses half interest, whatever their basis was, becomes yours.
Heidi: Well, let’s say it’s a stock account, an investment account?
Jonathan: Same thing. Think of it as the key I always tell clients, you’re stepping into the shoes of the former owner, because there’s been no taxation. The Tax Code says we want to preserve all the built-in tax, so it’s covered at some point.
Heidi: Is there something I guess relatively simple that you would recommend somebody consider when they’re thinking about filing for divorce or separating from their spouse?
Jonathan: I think when you’re looking at division of assets, one of the biggest mistakes I see is people don’t consider the after-tax impact. There’s a big difference between accepting somebody’s retirement which is all pre-tax and accepting, you know, somebody’s say home- where you could avoid gains if it’s your primary residence. A lot of times I explained to people, you think you’re dividing something evenly, but if I show you how it nets out after taxes would be paid in the future, it’s not even. So, it helps to keep things equal is what I tell people they need to think about. I also have told some people, when I’m helping in divorce, you know, understand they’re not, there’s a lot less benefits to divorcing parties, it’s going to be more expensive. You don’t get to deduct your attorney’s fees; you don’t get alimony anymore. I usually say you would probably want to be real careful about trying to just reach some separation, one big payment separation and move on. That’s what I’m seeing more of a trend of not long-term commitments. What I think some people just call making just a separation and equalizing the assets and moving on.
Heidi: So, one thing that you and I haven’t talked about before, but I just thought of, and I find interesting: Oregon recognizes registered domestic partnerships. And I understand federal law does not recognize that is that accurate?
Jonathan: Yeah, this comes up like with divorcing people who are in those relationships, and then you try to pass a retirement asset to the other, you don’t get the tax-free treatment, because they’re not defined as a married couple. And that’s what that’s what I run into a lot when it comes to dividing the asset. “Hey, guys, this is not going to be a tax, what you think is going to happen won’t happen, because your domestic partners.”
Heidi: Is that something you could address in a settlement? For example, could you write into the judgment that the, let’s say the one of the spouses, the alternate payee is going to receive a portion of a retirement benefit? And under the Tax Code, it would still be taxable to the payor or the owner of the account? Can you include something in a judgment that says it’s going to be treated differently from an income tax standpoint?
Jonathan: That would probably not be okay, because it’s sort of using a state court judge to override a federal provision. To me, that’s different than the dependency exemption where the government is just saying only one of you can claim it. This is like, no, it’s not allowed. You can. I mean, I guess what you could do in your judgment is one of the spouses could be responsible for grossing up the other spouse for covering the taxes that are caused. That’s the only solution I would come up with because that’s the only way I know you could replicate and get people back to the situation as if they were divorcing. But that goes into, like you said, your calculus of what you should think about. But that is a huge issue that that gets not discovered until you’re into the divorce. And it’s a huge number, and it upsets the balance. So, if I’m never consulted early on, I usually bring that up like, is there a lot of retirement here? Are there a lot of assets that aren’t going to be helpful in a non-married situation?
Heidi: All right. Thank you.
Jonathan: Thank you.