Hurry up — Get your clients divorced
Divorces aren’t normally seen in a positive light during the holiday season, but they may prove to be a valuable gift to certain clients this year.
The phones have been ringing constantly since September for Source Financial Advisors CEO Michelle Smith, who specializes in divorce planning.
Due to a statute set to go into effect in 2019 under the Tax Cuts and Jobs Act, Smith and her team have about 35 clients that need immediate attention — they all have a hard deadline of Dec. 31.
“It’s nonstop,” Smith says. “It’s 24/7 right now.”
When the tax overhaul bill became law in 2017, there was an important change for couples looking to split: Spousal payments would no longer be tax deductible for the person writing the check.
After Dec. 31, the payor, not the payee, will be responsible for the income tax on maintenance.
For example, if a spouse were to pay $20,000 in alimony right now in Missouri, he or she would receive a federal tax deduction of $4,800 (at 24% tax), plus a $1,200 state tax deduction (at 6% tax), according to an article published in the Journal of the Missouri Bar. The spouse would end up paying only $14,000.
In turn, the spouse on the receiving end would get $20,000 in alimony, and only have to pay $2,400, because they are in a lower income tax bracket at 12%, as well as the identical $1,200 in state tax deduction. Therefore, the spouse receiving the payment would pocket $16,400.
Under the new tax law, the same couple would deliver the federal government an additional $2,400 in taxes.
A spouse paying $20,000 in maintenance in Missouri would pay $20,000 in after-tax dollars. The income would have been already taxed federally at 24%, or $4,800, and been subject to the 6% state tax at $1,200. The spouse receiving the payment will receive the $20,000 without any tax requirement.
The shift marks a significant one for tax planning around divorces, according to Dan Prebish, director of life event services at Wells Fargo Advisors.
“I can’t even remember when there was a change as meaningful as this one,” he says.
But the motivation was clear to him. It was less about policy, and more about increasing revenue, Prebish says.
While theoretically, the spouse on the receiving end is pocketing more in alimony, there’s less money going to the parties involved, and more to the IRS.
Pre-2019 a spouse that agrees to pay $14,000 out-of-pocket would deliver $16,400 to the payee, and the IRS would get $2,400. Next year, a spouse will have to pay $16,400 to deliver $16,400 into the pocket of the payee, and the IRS will have walked away with $4,800 in taxes prior to the transaction.
It’s beneficial to all parties to complete the divorce sooner, Smith says. Taking advantage of the expiring tax cut helps the whole family.
Spouses are rushing to sign the dotted line — but divorce is never a fast process.
“Even if you agree with the spouse, you’ve got to go through drafts of a legal document that can be 45 to 90 pages,” Smith says. “It’s not just the finances. A divorce agreement is equitable distribution of property, spousal support, child support, parenting. It’s a lot… And if you really didn’t get it together until September, it’s a stretch.”
Retirement assets received in a divorce settlement may be available to creditors, a federal court has ruled. The decision may have far-reaching consequences for clients.November 28
There are only two ways to make a tax-free transfer of IRA assets in this situation.
While tax specialists have known about the upcoming changes for the entire year, couples looking to get a divorce might not have had much of a warning, according to Prebish.
“It was announced, but most people don’t read tax laws,” he says, adding: “Were someone to have talked to a lawyer or an accountant early on, they probably would have gotten a heads up.”
But even couples that discovered the change earlier in the year might have trouble getting their ducks in a row by the end of this month.
“If you just decided this past March you were really going to separate and get divorced… It’s a short time frame,” especially with the summer included, Smith says.
While some couples simply did not know of the change, others might have procrastinated, or not realized the money at risk. But a few months ago, people have started paying attention, especially payors, Smith says.
However, it’s not chaotic for all advisors. At Wells Fargo, only a small number of planners specialize in divorce, and the volume of questions coming to the home office regarding alimony tax law changes hasn’t been significant, according to Prebish.
Divorce attorney Jenifer Foley says she was fielding more questions closer to the announcement of the tax law changes. This time of year she isn’t feeling any more pressure than normal.
In fact, the shift in tax law might even make her job easier in the future, Foley says. Calculating the deduction is complicated, and this will be one less thing to fight about, she says.
“[With] child support, you never fought about the taxes,” Foley says. “You never tried to figure out if you could deduct it. You just tried to figure out what number was the right number.”
And most spouses don’t feel as if they are getting the better end of the stick in a divorce anyway, Prebish says.
“In a divorce, most of the time both people end up walking away feeling that the result was unfair or wasn’t quite what they wanted,” he says. “So it’s not going to be pleasant for people to have to deal with, but as with most tax law changes, eventually negotiators adapt.”
Still, a simpler negotiating process in the future doesn’t relieve immediate pressure of clients anxious to split up before 2019.
Smith is taking “no holiday vacation this year,” she says. “You’ve got to be available.”