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New tax laws add complexity to high-asset divorce settlements

On behalf of Shelly McKeon

The new federal tax laws that went into effect this year are making divorce settlements more complicated for certain couples. In particular, divorces involving substantial assets are likely to be affected by the new tax laws.

On January 1, 2013, the American Taxpayer Relief Act went into effect. Congress enacted the measure in order to avoid the “fiscal cliff” – an assortment of spending cuts and increases in taxes that were scheduled to go into effect if Congress failed to take action.

But although the legislation succeeded in forestalling certain financial perils associated with the fiscal cliff, it also created a few new obstacles for affluent married couples who choose to part ways in 2013.

Alimony may increase tax liability

Alimony is one aspect of divorce that may be affected by this year’s tax changes for some couples. One of ATRA’s main provisions is a tax increase for higher incomes; for single filers, the tax rate increased from 35 percent to 39.6 percent on all income exceeding $400,000 per year. Because alimony payments are typically treated as taxable income for the spouse who receives them, the payments could have the effect of bumping that spouse into a higher tax bracket – effectively decreasing the value of his or her divorce settlement package.

Some spouses who wish to minimize their tax liability after divorce choose to negotiate a single lump-sum payment in lieu of ongoing alimony payments. In these cases, the spouse who would otherwise be making monthly alimony payments instead pays a single negotiated amount up front. Unlike alimony, these lump-sum payments typically are not treated as income for the receiving spouse. Likewise, lump-sum payments in lieu of alimony generally are not tax deductible for the paying spouse.

Division of assets may also be affected

Even before the recent changes to the federal tax law, asset division was often one of the most complicated parts of divorce. Now, the new tax laws have added another layer of complexity to the property division process for some couples.

For instance, a new Medicare surtax on investment income and an increased capital gains tax for higher-income individuals may affect the value of certain assets involved in the property settlement process. Depending on the tax burdens that may be attached to particular assets, this may affect how divorcing spouses choose to negotiate the structure of their property settlement agreement.

People considering divorce and its potential impact on their finances should seek advice from tax professionals and divorce attorneys who can help them obtain a thorough understanding of the many variables involved. These professionals can help divorcing individuals weigh their options and assist them in pursuing a settlement that is optimally structured to meet their objectives.

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