Looking ahead: Tax considerations in divorce

| Jun 15, 2021 | Property division

It should be stated at the very top of this post: We don’t take political positions in our blog. Longtime readers know we’re focused exclusively on Orange County family law matters.

However, we’re going to take a look at a new Biden administration tax proposal that, if enacted, would impact property division in high-asset divorces.

The numbers

The proposal is to raise the top income tax rate from 37 percent to 39.6 percent. The current top rate applies to those filing as single or as a head of household and have incomes of $518,401 or more.

Taxes on capital gains would nearly double, going from the current 20 percent to 39.6 percent.

‘Pretty significant’

Certified financial planner Stacy Francis, president and CEO of Francis Financial, says the repercussions of the proposal will be “pretty significant” for divorcing couples. Higher taxes would mean that there will be fewer assets available to begin a post-divorce life.

“We see that after divorce, for men and women, the standard of living plummets,” Francis said.

Selling assets

To make ends meet when establishing a new household, spouses might be compelled to sell assets they received as part of the divorce settlement.

To illustrate the point, CNBC used as an example, a spouse who sells a $500,000 stock portfolio that includes significant gains. The sale would increase his or her income and might expose the profits to the nearly doubled capital gains tax.

House for sale

Another scenario: a couple bought a California house decades ago for $250,000. The property is today worth $1.7 million.

If the couple sells it while they’re still married, they could qualify for a $500,000 tax write-off on their big gain. But if a spouse sells it after the divorce, that person might qualify for a write-off of only $250,000.

“It’s one of those things that a lot of divorcing couples don’t think about,” said Eric Toya, a certified financial planner in Redondo Beach.

If that person sells the house for $1.7 million, their annual income might also be taxed at the higher income tax rate proposed by the administration.

None of the calculations here include California’s income tax and capital gains tax.

Taking protective action

Financial planner Aviva Pinto said that although no one knows the future of the proposed tax hikes, couples planning to divorce might take steps to finalize the process before the tax boost takes effect, or they might do well to sell their house sooner rather than later.

“Don’t let it drag on,” Pinto said. “A lot of the courts are just opening, and there’s a huge backup.”

She said people need to think ahead about the tax impacts of property transfers such as homes and investment portfolios.

Navigating the future

Said Francis, “so many times, people are just looking for the finish line of the divorce. They don’t think about how they’re going to navigate their life afterward.”

You can begin the planning process by contacting a skilled Orange County family law attorney experienced in divorces involving significant assets and property division disputes.