On August 5, 1997, President Clinton signed the Taxpayer’s Relief Act of 1997. Certain provisions of the Act will have an impact on how Family Law Practitioners should plan for the division of marital property incident to a dissolution of marriage and the support of children both before and after emancipation.
Under 750 ILCS 5/503(d)(12), the Court is to take into consideration in the disposition of marital property pursuant to a dissolution of marriage, the tax consequences of the property division. Section 1(h) of the Internal Revenue Code, as amended by the Act, decreases the capital gain on property held for more than eighteen months from twenty-eight percent to twenty percent and, in some situations, to ten percent.
Under IRC Section 121, as amended, there is now an exclusion from income of up to $500,000.00 in capital gain on the sale of principal residences for married persons filing a joint return and up to $250,000.00 for single persons or married persons filing separately. At the same time, IRC Section 1034 has been repealed and, thus, there is no longer the right to roll over gain from the principal residence. The new exclusion provisions also replaces the prior once-in-a-lifetime $125,000.00 exclusion for qualifying home sellers aged fifty-five or over. There is no age limit and the new exclusion may be used once every two years. The exclusion applies to a principal residence which is defined as being owned by either spouse for at least two of the five years before the sale if both spouses used the house as a principal residence for at least of two of five years prior to the sale.
If neither spouse is ineligible to take the exclusion, then, on a joint return, they may exclude $500,000.00 in gain. If one spouse is unable to use the exclusion because they have used it within the last two years, $250,000.00 of the gain can still be excluded if the parties file separately. There are also relief provisions for "forced sales" of the residence.
Of particular interest to the divorce practitioner is the provision that if an individual receives the house in a transaction under IRC Section 1041 (non taxable transfer to a spouse or former spouse pursuant to a decree of divorce), the recipient’s holding period can include the transferor’s (former spouse’s) holding period.
Under 750 ILCS 5/503(d)(5), the Court can consider the desirability of awarding the right to reside in the family home for a reasonable period after the divorce to the spouse having custody of the children. Under prior law, the transferring spouse might lose the right to roll over the gain from the residence should the sale take place more than two years after he or she has left the home. Under the new rules, if the sale period is more than two years after the divorce and the continued residency is pursuant to a written divorce decree, separation agreement, or marital settlement agreement incorporated into a divorce decree, the non-residential spouse is treated as using the home as his principal residence during the period in which the former spouse is granted the use of the property. There is no longer a tax detriment to the non-residential spouse in allowing the custodial parent to remain in the marital residence in excess of two years.
Child Support Impact
In the Second and Fifth Districts of the Illinois Appellate Court, the dependency exemption is to be awarded to the parent who contributes the majority of the child’s support. IRMO Rogliano, 198 Ill. App. 3d 404, 555 N. E. 2d 1114 (5th Dist. 1990); IRMO Clabault, 249 Ill. App. 3d 641, 619 N. E. 2d 163 (2nd Dist. 1993). The Third District has held that the trial court has the discretion to award the dependency exemption to the non-custodial parent. IRMO Van Ooteghem, 187 Ill. App. 3d 697, 543 N. E. 2d 899 (3rd Dist. 1989).
Under the 1997 Taxpayer’s Relief Act, there is now a new non-refundable child tax credit. The child tax credit, under IRC Section 24, will be $400.00 per child under the age of seventeen at the close of the year 1998 and $500.00 per year after 1998. In order to claim the child tax credit, you must be entitled to claim the dependency exemption. Therefore, the award of the dependency exemption will provide a double benefit, i.e., the tax deduction of $2,650.00 as indexed by inflation under Code Section 151(d) and an additional tax credit, which is a dollar for dollar reduction in taxes, under IRC Section 24. The eligibility to claim the new tax credit phases out, beginning at $75,000.00 of income for singles, $110,000.00 for married filing joint returns, and $55,000.00 for married persons filing separately.
750 ILCS 5/513 provides for the support of non-minor children and educational expenses. The new tax act provides tax relief for education in a variety of provisions. These include tax credits, penalty-free withdrawals from IRAs, deductions for student loans, educational IRA contributions and qualified state tuition programs. Careful planning can incorporate these tax savings in the provisions for educational support.
Under IRC Section 25A, there is now a "Hope Scholarship Credit." This Credit is equal to $1,500.00 for tuition and fees paid in the first two years of college. The credit consists of $1,000.00 of the initial tuition and fees and fifty percent of the second $1,000.00 in tuition and fees actually paid. No credit is allowed for room and board. IRC Section 25A also provides for a new twenty percent credit for tuition and related expenses up to $5,000.00 during the tax payer’s lifetime for undergraduate or graduate school. This credit may not be taken in the same year for a dependent for whom the hope scholarship credit is claimed.
Under IRC Section 72(t), the new act allows a penalty-free withdrawal from IRAs for tuition, fees, books, supplies, required equipment and room and board for the taxpayer, the taxpayer’s spouse, children or grandchildren for either undergraduate or graduate level courses.
Under IRC Sections 221 and 62(a)(17), there will be an above-the-line deduction for student loan interest during the first sixty months that interest is required to be paid under a student loan. The deduction is limited to $1,000.00 for 1998, $1,500.00 for 1999, $2,000.00 for the year 2000.00 and $2,500.00 per year for the year 2001 and subsequent years. The deduction is available whether or not the taxpayer uses a standard deduction or itemizes.
IRC Sections 530, 48973(e), 4975(c) and 6693 establish an educational IRA. The taxpayer may make a non-deductible contribution to an educational IRA of up to $500.00 per year for each child through the age of eighteen. This IRA is phased out between $150,000.00 and $160,000.00 of income for joint return filers and $95,000.00 to $110,000.00 for non-joint returns. The non-taxable withdrawal may be made to pay the child’s educational as long as the Hope Scholarship Credit or Lifetime Learning Credits are not used for the same child for that year.
Under IRC Sections 529(c), 529(d), 529(e), and 135(c)(2)(C), qualified state tuition programs have been expanded to include room and board. A taxpayer may contribute to a qualified state tuition program and the earnings will not be taxed until the beneficiary uses them. This tuition program funding provision qualifies for the $10,000.00 annual gift tax exclusion and if more than $10,000.00 is contributed in one year, the taxpayer can elect to spread the contribution ratably over five years in order to claim the exclusion.
The foregoing description of the new tax provisions provided by the Taxpayer’s Relief Act of 1997 is not exhaustive. However, it is clear that with careful planning, these new tax provisions can be used to benefit your client in the planning of a dissolution of marriage and the future support of your client’s children.
Joel D. Arnold is a Principal of Fortunato, Farrell, Davenport & Arnold, Ltd., Westmont. His practice is concentrated in taxation. He received his Undergraduate Degree in 1970 from North Park College, his Law Degree in 1973 and his LLM in Taxation in 1984 from John Marshall.