Archive for September, 2018

How New Tax Law May Increase A Divorce Settlement

In mediation and other methods of non-litigated settlement processes, the goal is not for the mediator or neutral to remain solely as a referee.  This person may also offer information to the couple about their process.  This may be through providing legal or other information and what-if brainstorming sessions.  The idea is to generate awareness of issues that impact what the couple is doing and how to come to agreement creatively.

One example is with the passage of the 2017 tax reform bill.  The tax changes may make support agreements tougher to reach.  In the past, the government participated in the process by offering one side a tax deduction, and the other side claimed the income.  In the real world, this provided tax savings for the paying spouse.  Income was shifted from a higher tax bracket to a lower one.  That tax savings increased the income options of the lower income spouse while providing a tax break to the higher income person.

The New Tax Rules

That is gone after December 31, 2018.  For those racing for the “exit” before that date, the option of filing a legal separation with the court and entering into a spousal support agreement may preserve the deduction for when the divorce is final in 2019.  But even that option, if successful, will run out on December 31 of 2018.

But there is another part of the code that impacts business owners going through a divorce.  This may be especially true for those with a spouse-partner in the business.

Under revenue code section 199-A a taxpayer may be eligible for a 20% reduction in income based on the profits of the business.  This article is not going to explain the code section or how it may apply specifically.  We do want to bring up the fact that taxes and tax savings are financial assets to be considered in negotiations.

For example, under the new rules, if a spouse owns a business with $100,000 of eligible profit, there may be a $20,000 deduction against all other income on the tax return.  That deduction could result in significant tax savings and a component for the support negotiations.

In the negotiation, if support is $48,000 annually, with the elimination of alimony deductions, that would cost the paying spouse $25,846 in taxes ($73,846 X 35% = $25,846).  That is an expensive payment under the new rules.

With 199-A that calculation may change.  The taxable income may now be reduced by the 199-A deduction.  The idea under the new tax law is to reduce the tax impact on business owners.  The business tax rate drops from the higher personal rate to one that is comparable with the new lower corporate tax rates.  This is done through a deduction.

Under a simple calculation, assuming that the overall effective rate is 21%, the amount needed to pay the same support payment is now $60,760 ($60,760 X 21% = $12,760 in taxes).  This is about a $13,000 tax savings.

The net result in both cases is a payment of $48,000 in support.  With this new 199-A deduction, for some business owners, it is a way to pay less in taxes.  For others, this may be a way to stretch dollars and provide more in support.

Another side of the code section is the impact of salaries paid.  Those are also part of the calculations.  With a divorce, if the spouse had been involved in the business, depending on the post-marital relationship, options around salary and benefits may be another way of shifting income.  This course of action requires that a salary is justified.

In more contentious situations this may not be possible.  But the financial impact of this option may push some to reach a more peaceful and accommodating arrangement.  With divorce being inevitable and support as a required component, making a couple aware of the tools open to them is one role of a mediator and consulting attorney.

These are only illustrations of a concept.  This is not personal tax advice or a projection of a specific tax consequence.  Each person will need to run these complex illustrations for their situation.  But the concept is clear.  Tax issues matter and have a financial impact on divorce.  Take a closer look through One Last Look™ to review issues as they may impact a specific situation.

Armand D’Alo and Robbin D’Alo

Working Through Financial Stress in Marriage & Divorce

Money: A Path to Trouble or Peace

One of the common reasons cited by couples for divorce is financial stress.  They indicate things like too much debt, not enough income, someone not carrying their financial weight, overload of expectations not being met, and more.  Each one or any combination build towards financial stress in the relationship.

The fact is that financial matters may not be solved in divorce.  They may be compounded.  Instead of one household, there are now two.  The debts are typically an obligation of both people.  Taxes are also going to follow both if the returns were jointly filed.  Houses, when sold, may be used to satisfy debts, but then where do people go to rent?

Looking at housing, if there are children, it may be desirable for them to remain in their current school.  This requires a rental for at least one person to remain in the area.  In addition, there is the need for the other parent to have a place large enough to provide a suitable environment for the children.  The result is a more expensive living situation.

How to Handle Money

In marriage or divorce, the first step is to work through the details.  This starts with a picture of the couple’s current financial situation.  Awareness is a major key to moving forward.  Both sides need to understand what is available and how they arrived at that point.  If people are not aware of how they got here, the possibility of correcting the situation is diminished.  This is true regardless of their relationship choices.

It is interesting that in divorce, when one side files, there is a restraining order placed on the major financial accounts and assets of the marriage.  Changes in beneficiaries, withdrawals of significant amounts of money, and termination of insurance contracts are barred.  The only way a change occurs is with mutual consent.  The one exception is to cover the obligations of the community.  But even that needs to be disclosed and monitored in proximity to the expense.

This is actually a good pattern for couples to learn, married or divorced – sharing information and making decisions together.

War and the Choice for Financial Ruin

The use of legal counsel is always advisable in divorce.  The issue does not have to do with obtaining legal counsel.  The problems arise with how the attorney is used.

When couples refuse to cooperate, hiring an attorney may be an expression of frustration and a method of taking back perceived power and control.  When the divorce turns to a litigated fight, both sides retain attorneys.  This leads to a typical retainer ranging from $3,000 to $10,000 each.  If the divorce is perceived to be more complex, that retainer will most likely be much larger.

Money roll and judges hammer on wooden tableIn litigated situations, it becomes a legal version of “telephone.”  Attorney A talks with spouse A.  Attorney A will then contact attorney B (if attorney B had not already contacted attorney A).  Attorney B talks with spouse B.  They develop a response.  Attorney B responds to attorney A who then confers with spouse A.

At this level of conflict, couples are encouraged to avoid speaking with each other.  The exceptions are in the required situations like an exchanging of the children.  Direct communication is cut – except through legal counsel.

At $350 to $450 an hour, plus staff fees and out-of-pocket costs, the legal bills add up quickly.  It does not take long before the retainer is drained, and a new retainer is called for.

From our experience, the typical litigated divorce can easily run up $30,000 to $50,000 in legal fees.  If there are contested issues around children and custody, the cost increases exponentially.  The court will require evaluations and possibly a court-appointed attorney for the children.  All those funds are lost from the estate – money that most couples cannot afford spending.

Peaceful Path Forward

The alternative is to plan out a path forward.  In marriage, this is reached by having a budget both agree to follow and a simple “policy” of two signatures required for every expense.  The two-signature policy fosters mutual agreement and ongoing financial awareness.

The practical approach for couples in any situation includes a monthly review of fixed expenses.  These are the largest bills which include the mortgage, car payment (if there is one), credit cards, utilities and any other costs to the family.  This will also include a review of any credit cards, their usage, the outstanding balances, and the payments.

The next part is the periodic monthly expenses.  There are “forgotten” periodic expenses like car insurance and homeowner coverage.  There are “surprise” expenses like medical deductibles, car, and house repairs.  Families also take vacations, have birthdays, anniversaries, and other expenses that “happen,” but may not be planned for.

Putting together a budget for these expenses allows couples to set aside funds each month.  These funds are moved into the “untouchable” savings account for use when needed.

What is odd to couples in divorce, is that all this information needs to be planned out and disclosed in their financial reports.  The very thing that drove the couple apart is the issue where they need to cooperate most.  Then at the end, it requires two signatures to sign off on the financial disclosures – including the income and expense reports.

These reports are required by courts.  But when litigating attorneys are involved, this can become an expensive process with each side issuing requests for financial information.  If it is not forthcoming, the request turns into a subpoena – the legal demand for information.  If the material is suspected to be incorrect, this escalates to hiring experts to do forensic evaluations – more costs.

Our observations through the years are that education is one key to successful negotiations.  In marriage or divorce it is important for both spouses to have a full understanding of their mutual financial world.  This helps both sides to know what is on the table and whether an offer is acceptable or not.

The Lessons

In marriage or divorce, cooperation is essential to economize and move forward.  If the marriage is so far gone that a couple will not work on the relationship, then it is best to cut those losses, set up an independent financial program and take care of the business of divorce.  But do not enter this with the illusion that life will go on as it was in the past.  Cutbacks and sacrifice are needed to make divorce or marriage work.

With divorce, most cases create a mutual agreement by the couple to keep the household running, and the children cared for.  That sounds impossible to some.  In situations when the other person does not cooperate, there are ways to move the process forward.  The court may be used to garnish wages and to seek access to assets independent of the other person’s cooperation.

In California, there are laws under the family code that allow access to assets for support and maintenance of the “marital standard of living.”  This does not mean that the same standard a person was accustomed to will be maintained.  But it does provide methods to seek funding for legal counsel and support payments while the matter is sorted out.

In California, this starts with a court filing asking for temporary support.  If the request for temporary support is refused by the other side, then an assignment of wages is an option.  This process is available when cooperation is absent.

While demands can be issued and a level of support obtained through the courts, this course of action is expensive.  The spouse that is compelled to pay will have their employer involved through a legal garnishment of wages.  The cost to both sides for legal counsel to maneuver this maze leads to more wasted assets.  Working it out before resorting to this measure makes better financial sense.

A Core Question

If couples are headed in the direction of litigation, we have a question for them to consider together.  Is a fight worth the financial and emotional cost?  We also explore the hidden costs when children are involved.  If children are aware of the divorce, they will most likely be aware of their change in circumstance.  They may also be aware of mom or dad not paying for their support.  That is a devastating message to a child.

Closing Comments

Our mission is to educate people about their relationship options, including divorce.  As couples approach a crossroad in their relationship, they may believe divorce is their only path.  The fact is that a divorce is one option among many.  It is one point on a continuum.  We encourage couples to take One Last Look™ before deciding.  Here is a place to explore options based on the couple’s own facts and circumstances.  They can see how the process might play out in the real world of separation and divorce.  Investing about four hours to save thousands in legal fees and heartbreak is worth consideration.

 

Armand D’Alo & Robbin D’Alo

Note:  Links in this article were active as of September 2018.