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Tax Reform and Divorce

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The tax reform legislation passed in late 2017 provides the most sweeping changes in the tax code in years. While there are a number of changes that will impact many of us in various ways, the changes in the tax treatment of alimony payments could have a profound impact on couples contemplating divorce.

Tax Reform and Divorce

Divorce is an emotional issue that can have a significant and lasting impact on the couple involved and their families. Divorce is also a significant financial event as well.

Alimony payments 

Under the current tax rules, alimony payments are a deductible expense by the ex-spouse making the payments. Generally, alimony payments are made by the ex-spouse with the higher income. The current rules shift the tax burden of these payments to the ex-spouse receiving the payments, who is often in a lower tax bracket.

The new rules that go into effect for divorces that are finalized after 2018 eliminates the tax deduction for alimony payments.

Under the current rules here’s how the alimony deduction would work at the federal level.

Income of ex-spouse paying alimony            $500,000

Federal tax bracket                                                 35%

Annual alimony payment                               $100,000

Tax deduction                                                   $35,000

After-tax cost of alimony                                 $65,000

Without the tax deduction the after-tax cost of the alimony increases to the full $100,000.

These changes could result in lower alimony payments going forward. The attorney for the alimony-paying ex-spouse could argue that the amount of alimony their client can now afford to pay will be reduced due to the loss of the tax deduction. If the argument is successful in reducing the amount of alimony, the ex-spouse receiving the payments will suffer financially on an ongoing basis as a result.

Boomers impacted

In a recent study, the Pew Research Center found that the rate of divorce among couples 50 and older more than doubled from 1990-2015. Many in this demographic are in high tax brackets and this change comes at a bad time for this group as they head into retirement. This is especially true if one spouse, often the wife in this age group, has been out of the workforce for a number of years raising children and/or serving as a caregiver to older family members.

Focus on divorce financial planning 

This change due to tax reform doesn’t change the fact that divorce is a major financial event that requires careful financial planning during the process by both spouses.

It is important the couple seek sound, unbiased financial guidance from a fee-only financial advisor to ensure that a settlement that is as fair and equitable for both spouses is reached. Moreover, decisions need to be made with as little emotion as possible. For example, keeping the family home may be a poor financial choice if the costs of ownership will be a strain on the ex-spouse receiving this asset. It is important that all marital assets be considered as part of this process.

For couples nearer to retirement it’s important to understand the rules governing Social Security benefits from ex-spouses. These rules remain intact and both spouses need to incorporate them in their retirement planning.

Summary

Overall the loss of this tax deduction is an incentive for couples looking to divorce to get things finalized in 2018 if possible. Delaying things until 2019 or beyond might result in a lower alimony payment and will result in less money for one or both ex-spouses. Pre-divorce financial planning remains a critical part of the divorce process.

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Six Things Your Divorce Attorney May Not Tell You

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This post was written by fee-only financial advisor Michelle Fait.

You may think coming to terms in your settlement puts the work of your divorce behind you.   The good news is, for the most part that’s true.  But before you pay that final invoice to your attorney, make sure you cover the following issues.  Your divorce attorney is trained in family law and the drafting of documents, but may not be as savvy in making sure those paper promises in your settlement are implemented, and that can put a bump in your path to a new life.  In short your attorney may not be well-versed in divorce financial issues.

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You May Not Be Able to Cancel Your Own Credit Card

If you are the secondary person (your name is listed second) on a joint credit card, the credit card company may not recognize your authority to close the account, even though you would be liable for any charges to it.  Make sure your attorney arranges for your ex-spouse to contact the credit card issuer to close your joint account, and ask for written verification of its closure.

Your Divorce May Not Trigger COBRA Eligibility

If you are expecting to be eligible for COBRA after your divorce, your ex-spouse’s benefits department will have to acknowledge that you are terminated from their plan. Unfortunately, you may not be able to do this directly.  Have your attorney ensure that your ex-spouse terminates you from the employer’s health care plan if you intend to move to COBRA, and coordinate this termination with your new coverage. Otherwise, you may have to appeal to the state authority and could risk losing your eligibility.

The Small Stuff Might Be Big

All those times work interfered with vacations or holidays?  All those business trips?  Your spouse may have a valuable stash of frequent flyer miles and vacation pay that should factor into your financial settlement.  Ask for an accounting of this information from the employer for accumulated vacation pay, and of your spouse for information on any frequent flyer accounts.

Here are Your Assets – Would You Like a Tax Bill With That? 

Especially with a rising stock market, you may be awarded assets that have an unrealized capital gain.  When sold, these assets could trigger a nasty tax bill for which you alone will be responsible. Your attorney might not assess your assets keeping in mind any tax liability that goes with them.  Consult with a CPA or other tax professional to calculate the after-tax value of any non-retirement assets you are splitting with your ex-spouse.

Filing a Joint Tax Return May Save You Tax But Cost You Anyway

Filing a joint return will almost always be more beneficial from a tax standpoint than filing separately.  But first make sure you are comfortable that all information has been disclosed.  You may not have knowledge now of any information that leads to an audit and/or tax bill and penalties later on, but you will be responsible for it nonetheless by signing a joint return.  In addition, be sure to ask for half of any refund or otherwise ask for consideration in exchange for the benefit of filing jointly. 

You May Not Have All the Facts

If you suspect your soon-to-be former spouse has not been forthright in disclosing information, have your attorney demand a credit report to check on any and all accounts that your spouse may have.  Follow-up with a request for statements for any accounts you don’t recognize.

Divorce is a difficult process at best.  But don’t be surprised by what your divorce attorney may not tell you – or know.  Their main responsibility is helping you through the legal maze of divorce.  Tax advice, health care insurance eligibility, and even estate work may not be their purview, but issues in these areas will impact your settlement and you must be vigilant in seeking the right expertise.

Michelle A. Fait, MBA, CFP®, EA founded Satori Financial LLC in 2001.  Michelle is a CERTIFIED FINANCIAL PLANNERTM professional (CFP®) with expertise in investments and tax.  She holds an MBA in Finance from Yale University, a bachelor’s degree in Economics from U.C. Berkeley, and is an IRS Enrolled Agent.  Her experience includes work as an investment banker in New York and Seattle for a major broker-dealer, and work for two start-up companies.   Immediately prior to founding Satori, she served as Treasury Manager for Starbucks Coffee Company, where she was responsible for cash and investment management and financial risk management. 

Satori Financial LLC is a boutique fee-only financial advisory firm that works with clients who want a partner to help them organize, simplify, and manage their financial lives in today’s chaotic world. Satori focuses its work on the planning needs of clients who are single, whether by choice or by chance, particularly those beginning again after divorce, and working professionals who want to outsource help with their financial lives.  Michelle is happily divorced and living in San Francisco.  You can reach Michelle at (206) 320-9263 and michelle@satorifin.com. You can follow Satori on FaceBook, its blog Eyes Wide Open, and Michelle’s crazy single life (along with the occasional tax tidbit) on Twitter: @michellefait

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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