If you faced a divorce or other legal proceedings recently, you may have been quite eager to leave them in the past and start anew. Unfortunately, you may have to deal with them again—or at least their financial aftermath—now that tax season is here because under the new Tax Cuts and Jobs Act (TCJA) laws you can no longer deduct payments made for alimony (for divorces post-2018) or certain legal bills. Given that these payments can often be significant it is important to know how this change may impact your freelance taxes going forward. Here’s a quick synopsis:
If you divorce and you or your former spouse become legally obligated to make alimony payments, starting this year you can no longer claim tax deductions for them. Before the TCJA’s reform of the tax code, payments meeting tax law requirements could be deducted by the payer on their federal income tax return while the recipient of such payments reported them as taxable income.
Starting this tax year, alimony payments are no longer tax deductible and recipients of them no longer have to include them in their taxable income. This applies both to 1) divorces executed after Dec. 31, 2018 or modified after this date if the modified agreement specifically states that the new tax rules shall be applied to these alimony payments.
In addition child support payments or payments to divide the marital property are also treated as nondeductible personal expenses for the payer and tax-free payments for the recipient.
Keep in mind the requirements for deductible alimony. If you have an alimony agreement that pre-dates 2019 it may still qualify as deductible alimony if it meets the following requirements.
Legal woes affecting you? Here’s what it means for your taxes. Tax reform ushers in higher taxes on lawsuit settlements with no deduction for attorney fees in some cases. For example, if you win a lawsuit in a $100,000 case, you will pay tax on the full $100,000, regardless of how much you pay in legal fees. However, there are two important exceptions:
In most other personal lawsuits, there is no longer a write-off for legal fees or costs, so you would be taxed on all of your recovery. At first this may not seem like a big deal, but when you consider it includes lawsuits related to issues such as privacy, defamation of character, divorce, child custody, wrongful imprisonment, malpractice, punitive damages and other common legal troubles the impact is likely to be much more widespread among taxpayers.
The impact of tax reform on legal fees cannot be overstated. The TCJA makes significant changes to the deductibility of alimony and personal lawsuit recoveries, which can really add up to a significant tax liability on your freelance tax return. Again, it is key to make sure you discuss your personal legal situation as it relates to taxes with a qualified professional.
Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.
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