Post-Election Income Tax Planning for Divorce and Beyond

We now have a bit more clarity about the future income tax landscape in the United States and the State of California specifically.

Here is what I know.

In 2013 the 0.9% Medicare surtax kicks in on taxable income over $200K for single filers and $250K for married filers.

In 2013 the 3.9% Medicare tax on unearned income such as dividends, interest and capital gains kicks in for single filers with taxable income over $200K for single filers and $250K for married filers.

President Obama wants the top rate on capital gains to rise to 20% for single filers with taxable income over $200K for single filers and $250K for married filers. He also wants the top tax rate to go higher from it’s current 35%.

What does this mean to you? It may be a good idea to sell appreciated assets in 2012. Taking gains in these assets in 2012 could save you the 0.9% Medicare surtax, the 3.9% Medicare tax on unearned income and 5% or more from the increase in capital gains tax rates.

For divorcing parties this might mean selling some appreciated assets such as stock positions or real estate in order to lock in the 15% capital gains rate and avoid the 3.9% additional Medicare tax rather than retaining them post divorce. It might mean exercising non-qualified stock options in 2012 to lock in the maximum 35% income tax bracket and avoid the additional 0.9% Medicare surtax.

California passed Proposition 30. Proposition 30 raises taxes on EVERYONE.

  • The income tax increases are RETROACTIVE to January 1st 2012
  • Sales tax rates  are increased by 3.45%
  • Three new high-income tax brackets are created raising rates from 9.3% to 10.3% for taxable income over $250K but below $300K (10.6% increase), from 9.3% to 11.3% for taxable income over $300K but below $500K (21.5% increase), from 9.3% to 12.3% for taxable income over $500K but below $1,000,000 (32.26% increase), and from 10.3% to 13.3% on taxable income over $1,000,000 (29.13% increase).

There is nothing to do about Proposition 30 at this point since the changes are all RETROACTIVE. It has amazed me how many people did not realize the measure was retroactive.

Beware Stock Redemption for Small Business in Divorce

small business, divorce financial analyst

Many of my clients own small businesses which bring a mountain of complications to the financial negotiations of divorce. From cash flow analysis to business valuation to perquisite incomes to ownership interests, the existence of a small business in a family net worth statement brings challenges and opportunities. One of the challenges becomes apparent when a couple wants to negotiate for one party to be awarded a business as part of the divorce settlement.

Here’s an example

Steve and Martha co-own a business we will call Divorce, Inc.. During the marriage Steve ran the business, was the face to all of the sales meetings and was generally known as the business man of the family. Martha had the idea for the business but preferred to stay behind the scenes and manage employees. Steve and Martha have always owned the 100 shares of stock 50/50. During divorce negotiations it became obvious that they were not going to both continue working in the business and so one should by the other’s interest. Since Steve was the face of the business and Martha had already set her heart on doing other things it was decided Steve would buy Martha’s interest in Divorce, Inc. at a total community property value of $2,000,000 after an appraisal was completed. There are a couple of ways to facilitate this transaction. This is where it becomes sticky.

 

  1. Divorce, Inc. will write Martha a check for $1,000,000 to buy her 50 shares from her.
  2. Martha will be keep other community assets (house, tax affected retirement accounts, brokerage account) worth $2,000,000 to offset the value of Divorce, Inc..
  3. Divorce, Inc. will purchase Martha’s 50 shares of stock over time at set prices based on an agreed upon stock buy-back plan.
  4. Steve will purchase Martha’s 50 shares of stock over time at price and on a timeline delineated in an agreement.
  5. Steve will purchase all of Martha’s 50 shares today by structuring a promissory note to be paid over time.
  6. Structure a buy-out payment over time to be payable as spousal support from Steve to Martha.

 

The result?

As you can tell you have options if you are negotiating the sale of a business interest pursuant to your divorce. Litigating your divorce removes many of these options as a judge is unlikely to create a situation that requires the couple to remain attached for long periods of time after the divorce. This means options #3 and #4 are thrown out. If there are no significant other assets in the estate option #2 goes away. If there is not a significant cash position on the books of the corporation option #1 goes away leaving only option #5. A court is not really allowed to be creative which rules out most of these on it’s own.

Each of these options also has complicated tax considerations to be incorporated when deciding how to structure a buy-out. Many tax professionals believe the only way to guarantee a clear understanding of how a tax court would rule is to ask for a private ruling. Some believe structuring a transfer of the stock inside of the Section 1041 six year requirement covers you. What is fairly clear is that forcing a Divorce, Inc. to purchase shares from Martha would result in some form of a taxable event so it may be best to consider options involving immediate offset with other assets or structuring a collateralized promissory note. Consult with your Divorce Financial Planning expert and Tax expert before deciding what works best for you before making a decision.

 

 

wellspring divorce advisors

Wellspring Divorce Advisors helps individuals and couples address the financial aspects of divorce in a civilized, equitable, and efficient manner by providing expert divorce financial planning and advice.

Contact us to find out how we can help you through this process.

Is Alimony Payment Tax Deductible

The general answer is yes but there are complications. Here is one of them.

Today a client asked if his Alimony (Spousal Support in California) payment was tax deductible for 2011 even if he is still technically married for tax purposes.

The answer is YES…..BUT.

Tax filing status is determined by marital status on December 31st of a given year so if he was still married on December 31st he generally (there are limited exceptions where it may be possible to claim Head of Household status) must file either Married Jointly or Married Separate. In order to deduct the alimony payments they must choose Married Separately. If the couple, now separated but not yet divorced, AGREE to both file Married Separately the alimony will be deductible to the payer and taxable to the payee. The BUT comes into play when you consider all of the other side effects of the Married Separate filing status. Consult your tax preparer for full details.

California Divorce Myths

Everyone has a friend or family member who has been divorced. Many will have heard horror stories or received tips about what they should do or what they should expect. I have heard “Mom always gets the kids” and “I earned the pension so it’s mine” People also make up there own expectations like “I made all the money, so I’ll get all the assets” or “I’ll get half of everything”. Here is a list of the top 11 Divorce Financial Planning Myths that come to my mind.

 

1. “I made all the money, so I’ll get the assets”
2. “Dad has to pay for college”
3. “Mom always gets the kids”
4. “Child support will take care of us”
5. “My spouse charged up the credit cards- they are not my debts”
6. “I’ll always get spousal support”
7. “We have small kids, so Mom gets the house”
8. “I earned the pension so it is mine”
9. “The courts will take care of me”
10. “I’ll get half of everything”
11. “We have no fault divorce in California so it must be easy”

Are More Women Paying Child Support and Spousal Support?

The quick and easy answer is yes. Both in statistics as well as our experience.

The American Academy of Matrimonial Lawyers (AAML) released a statement with a rather catchy opening sentence. “This Mother’s Day, it appears that an increasing number of mom’s will be setting aside time to sign child support and alimony checks.”

The key to note is that they are signing the front of the check, not the back. 56% of the AAML fellow attorneys said they have seen an increase in mothers who pay child support and women in general paying spousal support.

As our society progresses the social norms are changing and stay-at-home fathers are becoming more common. I personally support the family’s right to choose what is best for them and whoever is more inclined to be in the work force should be. It is encouraging to also see income in-equality becoming less of a concern as well.

I have seen an increase in women writing the support checks in my practice too and I am here to report the female support check writer is every bit as troubled about writing the child support or spousal support check every month as her male counterpart. In fact I might say even more troubled by having to write that check every month. Maybe this piece of the social norm shift hasn’t caught up yet. The stigma on men receiving spousal support or child support payments seems to be alive and well.

 

Read the full text of the AAML press release here. https://www.marketwatch.com/story/more-women-paying-child-support-and-alimony-2012-05-08