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Divorce Taxes and Changing Times
With a Democratic president and a larger Democratic majority in Congress, we can anticipate significant changes in tax laws and federal legislation affecting different aspects of our lives. What will these new laws mean for our divorcing clients and how should we protect our clients in anticipation of these new laws?
First, we can anticipate that our higher income clients, those with incomes over $250,000, may pay higher taxes; perhaps 40 to 44 percent could be the top tax rate. Individuals earning less than $250,000 will probably pay less taxes. For middle income families, less taxes for everyone will mean that the after-tax impact of alimony payments will be less significant and a less important consideration in our calculations. For high income families, where the breadwinner is earning in excess of $250,000 and there has been a stay-at-home parent, the increased tax effect is going to be significant. A Property Settlement Agreement negotiated on 2007 net tax income, fixing alimony based on those figures, could result in a real squeeze if the breadwinner’s net income is substantially reduced by rising taxes. Such an arrangement could create a windfall for mom if her taxes on that money are less.
Thus, starting immediately, in anticipation of changes, divorce lawyers should consider making alimony adjustable from year to year based on the payor’s net income thereby lowering alimony to be received by the dependent spouse, especially in the event that one is representing the breadwinner. If one is representing the stay-at-home parent, of course, such considerations would not be to his/her advantage and immediately locking in alimony using the old tax rates would be beneficial.
If the parties have substantial dividend or capital gain income, those assets will most likely be taxed at a higher rate. It has been conjectured that capital gains rates will go up to 20% and dividend rates could go up as high as 40%. These considerations are important in valuing options and weighting their value in the overall method of distribution in a case.
It is the usual practice with options to divide them 50/50 and have them distributed net of tax after exercise. This practice should absolutely be the rule in the future. Fluctuating future tax rates will make present offsets (asset swaps) risky. Given the recession, some options that have been granted may never be above water, especially in the financial and insurance industries. Increased tax rates on capital gains may make options which do have value, less valuable. The fluctuations relating to the changes in the capital gains rates can be shared by both parties if options are divided between the parties net of tax after exercise.
Government policy will ultimately impact our clients in various ways depending on the industry in which the breadwinner works. We have already seen that breadwinners in financial and insurance industries have suffered greatly. Management in those industries have stock holdings which have gone down dramatically, in some cases as much as 90%. The policy of the Federal Reserve and the government has everything to do with the survival of our financial institutions and insurance companies, AIG, for example. On the other hand, we should be mindful and anticipate the negative consequences of future government action under Democratic Congresses for breadwinners who work in the pharmaceutical industry and managed care. It is probable that a Democratic Congress will legislate for government negotiated prices on Medicare-provided drugs and otherwise squeeze the pharmaceutical industry, as well as regulate managed care providers to the benefit of the taxpayers, but not those industries’ employees and shareholders.
As we have seen, when one person has had a large proportion of the marital estate distributed to them in the form of one particular stock in a company that has declined in value, we can anticipate that they will end up with the short end of the stick, so to speak. It would be bad representation to negotiate disproportionate distribution of stock in companies that we think may have trouble in the future. Diversification within equitable distribution will be important in the future just as it is as a portfolio management tool.
Finally, we can anticipate that the bankruptcy laws may change. The bail-out bill, if acted on by the Treasury Department, would permit the courts to change the terms of mortgages and forgive the amount of a mortgage which is over the value of the residence serving as collateral, reduce interest, or lengthen the term of a mortgage. Pennsylvania is not a state in which there has been a super dramatic reduction in home prices, so this may not be so relevant in our area, but we do have families who have refinanced repeatedly using the equity in their home to take out credit card debt. They may be in a situation where a deficiency judgment along with real estate tax liens could put them in a negative value situation.
Ironically, the bankruptcy laws that were passed recently helped creditors in that they restricted Chapter 7 discharges and forced debtors into Chapter 13 workouts. In a recession it will be interesting to see whether or not the federal government will liberalize the availability of Chapter 7 discharges. Whether or not they liberalize the availability of Chapter 7 discharges, all divorce lawyers in this recession context should be aware of the debtor counseling requirements and services which are available under the Bankruptcy Laws, as many of our clients will need those services. Joint compliance with a program to retire debt may be a critical component of future property settlement agreements.
Divorce lawyers often feel helpless in the face of clients who have dug themselves into deep financial holes or are innocent victims of the recession. Next year will be one of rapid legislative change. It will keep all lawyers on their toes. We will have to constantly re-examine the advice that we give our clients and adjust our assumptions, in addition to helping them to get out of their marriages, as well as out of debt.
I conveniently represent clients in the Bucks, Chester, Delaware, Montgomery, and Philadelphia Counties, the towns of Wayne, Radnor, Philadelphia, King of Prussia, Paoli, Devon, Berwyn, Newtown Square, Villanova, Bryn Mawr, Haverford, Ardmore, Lower Merion, Media, Wallingford, and Swarthmore, and throughout Pennsylvania.
© 2015 by Elizabeth L. Bennett, Esquire. All rights reserved.
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