New Federal Tax Law Making Your Tennessee Divorce Settlement a Little Squirrelly?

What does the American Taxpayer Relief Act of 2012 (ATRA) have to do with your Germantown, TN, divorce settlement? Everything if you don’t plan your separation agreement, alimony, and property division very carefully.

New federal tax law can impact Germantown TN divorce settlement

Following the memorable 2012 “fiscal cliff” debates, the ATRA was passed and became effective January 1, 2013. Tax preparation season will be upon all of us very soon and, for better or for worse, the ATRA could serve a prominent role in your income liability for the 2013 tax year and beyond. If your divorce is pending, or about to be, then pay attention to the ATRA provisions noted below.

When Alimony Pushes You into a Higher Tax Bracket

Absent an agreement to the contrary, alimony is ordinarily taxable as income to the recipient. (The payor deducts spousal support from income and the recipient adds it to income.)

The ATRA does not change that. What it may change, however, is the filer’s tax bracket. For those individual filers with an annual taxable income exceeding $400,000 when alimony is included (exceeding $450,000 if married filing jointly), the tax rate on income will be 39.6%. That’s up significantly from 2012’s rate of 35%. (Although the consequences of the ATRA are not restricted to women, Forbes contributor Jeff Landers raised some excellent points in his ATRA article for Divorcing Women: Will the New Tax Laws Impact Your Divorce Settlement?)

This means that, when negotiating a divorce settlement, the spouse who seeks alimony should carefully consider the income tax consequences. For some, a property settlement in lieu of alimony (wholly or in part) may be more beneficial in the long term.

In Tennessee, for example, the spouses may agree to alimony in solido (lump sum alimony) as part of their property settlement. In general, when alimony in solido is awarded in the divorce as a component of the parties’ property division, there is neither deduction from the payor’s taxable income nor addition to the recipient’s taxable income relating to that lump sum.

If receiving alimony could push your taxable income over the $400,000 threshold for an individual filer (or $450,000 with a joint return), do some advance tax planning before the separation agreement is finalized.

Icing on the Cake: Capital Gains Tax and the Medicare Surcharge

For those whose taxable income with alimony will saddle them with a 39.6% tax rate, there are other taxation concerns as well. The ATRA raised the capital gains tax for these individual filers to 20% (that’s a 5% increase over the prior tax year), with a Medicare charge of 3.8% tacked onto the capital gains, too. That’s a combined total of 23.8% targeted at capital gains for 2013.

Does your post-divorce financial plan include liquidating assets such as real property or other investments as a way to supplement living expenses? Then the capital gains-Medicare tax combo may make that plan far less beneficial than you might hope. Certainly, the spouse with plans to take appreciable assets away from the divorce as part of a separation agreement has some serious number-crunching to do. The wiser spouse will not advocate a specific position during negotiations until after consulting with a divorce lawyer and tax professional.

For more information about federal tax law and the Tenn. divorce settlement, take a few minutes to read:

Divorce and Taxes | TN Divorce Law & Tax Resources

Always Seek Competent Tax Advice

You should always seek tax advice from a Certified Public Accountant or tax attorney. For a list, see our Memphis TN Divorce CPA and Tax Professionals Directory or call Miles Mason, Sr., for a referral. This article provides an overview only and exceptions may apply to your particular situation. For more detailed information, See IRS Publication 504 Divorced or Separated Individuals at IRS.gov.

Tennessee Divorce Attorney and CPA

Memphis divorce attorney and CPA, Miles Mason, Sr., practices family law exclusively and is founder of the Miles Mason Family Law Group, PLC. Check out The Tennessee Divorce Client’s Handbook: What Every Divorcing Spouse Needs to Know, available on Amazon and Kindle. To schedule your confidential consultation, call us today at (901) 683-1850.