New legislation magnifies the impact of taxes as there are increased income tax rates, limits on deductions and a Medicare surtax that all became effective January 1st. To estimate how much the embedded tax liability is when calculating the after-tax value of proposed divorce settlements, it is critical to pay attention to key terms on your tax return. While the new laws affect primarily high income taxpayers, anyone going through a divorce should be aware of the impact of taxes to make sure they are getting an equitable settlement.
Adjusted Gross Income (AGI) – total gross income minus retirement plan contributions and potential other adjustments. If your AGI is over $250,000 as a single taxpayer, the benefit of deducting the children and itemized deduction such as mortgage interest will be reduced. An individual whose AGI is more than $375,000 will receive no benefit from the dependency exemption for kids and should consider whether to use Form 8332 to let the other parent take the exemption.
The 3.8% Medicare surtax is assessed on investment income such as taxable Interest (not Municipal Bond Interest), dividends, capital gains and annuities when a single taxpayer has AGI in excess of $200,000. This can result in higher taxes when selling assets to equalize a divorce settlement or provide cash to pay expenses.
Taxable Income – AGI minus allowances for personal exemptions and itemized deductions. This is the income amount that determines your highest marginal tax rate which is now 39.6% for individuals with income in excess of $400,000. Capital gains increases from 15% to 20% for these taxpayers as well, which increases the importance of clarifying how any capital loss carry-forwards will be allocated during a divorce.
Keep in mind, these are federal income tax rates only and state income taxes would be additional. The complexity of the new tax laws make accurate tax estimates during the divorce process even more important to understanding the real value of your settlement and to make sure you are making proper quarterly estimates to avoid penalties.
Heather Locus is a principal at Balasa Dinverno Foltz LLC, a fee-only wealth management firm with approximately $2.5 Billion under management. Heather is passionate about helping women make smart financial decisions so they can enjoy their wealth. As an owner and leader of BDF’s Women’s Service Team, Heather provides financial guidance to divorcees and business owners before, during and after the challenging transitions in their lives. Visit her firm website.