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Wealthy taxpayers' plans to end their marriages this year just got more complicated, thanks to the new federal tax law.
January is one of the most popular times to file for a divorce. So some advisers have started to plan settlements for their wealthy clients who face tax increases on income and investments under the American Taxpayer Relief Act.
The new tax regime has forced advisers--working with divorce attorneys and tax accountants--to think more carefully about several aspects of divorce agreements, such as whether to include alimony, and how to divide up stock portfolios, pension plans, executive pay packages and other assets.
A lot of clients divorce in January, after they've had time to reflect on their marriages during the holidays, according to advisers.
Sometimes, tax considerations play into the timing of a split. A pair who decided to part ways back in April 2012, for example, may have waited until this month to make it official. The delay would let them cut down on their taxes by filing jointly for 2012.
Alimony is getting attention now, as it could raise adjusted gross income above $400,000, the new threshold for the top income bracket for single filers, with its 39.6% rate. Alimony is deductible by the person who pays it, and reportable as income by the one who receives it. Child support, in contrast, is neither deductible nor reportable as income. An adviser can choose one or the other, or both, to write a divorce agreement that best suits a client.
"High-income clients are asking what they should talk about to their accountants," said Alton L. Abramowitz, president of the American Academy of Matrimonial Lawyers.
A hedge-fund manager recently asked Mr. Abramowitz if he should give away some of his $4 million of deferred compensation in his divorce settlement. The adviser will look at when the money is to be paid out and when options in the pay package vest for a sense of how much tax the client could eventually owe on the money. Then, he'll weigh whether it would lower his tax bill to part with his beach house in the Hamptons or condominium in Manhattan as part of the settlement."Now, more than ever, I'm going to be more mindful of how to treat alimony," said Bari Weinberger, an attorney in Parsippany, N.J.
Ms. Weinberger wants to reduce alimony for a client who is ending her marriage to an athlete who earns about $2 million a year. The man would have to pay about $800,000 a year in alimony to support the woman in the lifestyle to which she has become accustomed. He would get a nice tax deduction, but the client would be saddled with a lot more taxable income.
As a result, Ms. Weinberger may argue that in lieu of alimony, the man should pay for the upkeep of some of the real estate the woman will get in the settlement. She plans to split her time between a place in Tuscany, a shore house in New Jersey, and a townhouse in Manhattan.
Investment portfolios are also core to many divorce agreements. A new 3.8% Medicare surtax on capital gains, dividends and other investment income over $200,000 of adjusted gross income is likely to prompt more "horse trades" over portfolios, said James H. Guarino, an accountant and certified financial planner at MFA--Moody, Famiglietti & Andronico LLP in Tewksbury, Mass.
Instead of fighting for a client to get a portfolio that now will generate more taxes, for example, an adviser may recommend another asset, say, rental property that generates a tax loss, Mr. Guarino said.
Or instead of a 50-50 split on a portfolio, an adviser may hold out for a bigger share. "We might say, 'Wait, we want more of an allocation (say 60%) because we'll be paying more tax on it," said Mr. Guarino.