Divorce

March 2018 : Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act

Posted by Joseph W. Cunningham, JD, CPA

View / Download March 2018 Article – PDF File

— Prior to the 2017 Tax Reform Act (TRA), signed into law in December 2017, divorce related attorney fees and accounting fees were deductible as miscellaneous itemized deductions to the extent attributable to:

  1. Efforts to obtain taxable alimony, whether successful or not, and
  2. Tax advice.

This was beneficial to divorcing parties who saved taxes by deducting such fees. And, it was beneficial to attorneys to inform their clients that, in effect, Uncle Sam was going to subsidize payment of their fees, hence, making them more affordable.

But, under the TRA, the deduction of miscellaneous itemized deductions is eliminated effective January 1, 2018.

However, there does remain a little-known tax benefit available incident to the payment of divorce related attorney fees and accounting fees. To the extent such fees are attributable to the property settlement, they increase the tax basis of
assets received or retained by a divorcing party. This reduces taxable gain on future disposition.

Exception– The portion of fees allocable to cash cannot increase tax basis since cash can never have a basis higher than face value. Also, the portion allocable to all forms of compensation – payable currently (bonus) or deferred (pension, 401(k) account, IRA) – does not increase the tax basis of such assets.

Further, the amount allocated to a principal residence often will provide no benefit due to the large gain exclusion
available incident to sale.

Fees attributable to property settlement include–at least in part–time devoted to discovery, valuation, separate property issues, negotiations, preparation and participation in settlement negotiations, mediation, arbitration, and trial
proceedings.

Regarding valuation, if the asset valued is awarded to subject party, the entire fee for the valuation should be specifically allocated to the tax basis of that asset.

Otherwise, the “property settlement’” fee should be allocated among assets awarded to subject party proportional to their respective values. Assets for which an increase in tax basis is beneficial include a business, second home, stock portfolio, and other forms of investment holdings.

Example: A divorce in which each party paid $5,000 for an appraisal of H’s business

Attorney Fees Paid by Each Party:

– Attributable to child support and spousal support $2,000
– Attributable to working with business appraiser 500
– Attributable to other property settlement matters 2,500
– Attributable to other aspects of the divorce proceeding 2,500
– Total $7,500

Accountant/Business Appraiser Fees Paid by Each Party:

– Business valuation $5,000
– Tax advice 500
– Total $5,500

Fees Attributable to Property Settlement:

– Attorney $3,000
– Accountant 5,000
– Total $8,000

Fees Paid by W, the Non-Business Owner:

  • The $8,000 is allocated among assets awarded to W, including cash and any retirement benefits, proportional to their respective values.
  • Fees allocated to cash and retirement benefits do not increase their tax basis and, hence, no tax benefit is received from such fees.

Fees Paid by H, the Business Owner:

  • The $5,500 in fees attributable to the business valuation should be added to the tax basis of the business.
  • The $2,500 balance is allocated among assets awarded to H, including cash and any retirement benefits, proportional to their respective values.

Notification to Clients

Many attorneys provide clients with a letter of “to do’s” at the end of a case. These include changing beneficiary designations, executing deeds, obtaining a QDRO, etc.

Such letter should also include the specific portion(s) of the attorney’s and any expert’s fees attributable to property settlement with the suggestion to consult with a tax specialist to learn how to obtain a tax benefit from such fees.

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

About the Author:

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act”
View / Download March 2018 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “March 2018 : Remaining Tax Benefit for Payment of Divorce Related Fees under the 2017 Tax Reform Act”

February 2018 : Highlights of 2017 Tax Reform Act’s Effects on Divorce

Posted by Joseph W. Cunningham, JD, CPA

View / Download February 2018 Article – PDF File

— The 2017 Tax Reform Act was signed into law in December 2017. Some of its significant effects on divorcing couples are summarized below.

Alimony Deduction:

New Law

Alimony, that is, spousal support, will not be deductible by the payer or taxable to the payee for divorce and separation
judgments and decrees entered on or after December 31, 2018.

This also applies to modified judgments of divorce or separation effective after 2018.

And, it applies to divorce and separation decrees entered before December 31, 2018 if the parties elect to have the new law apply.

But, it does not apply to other divorce and separation decrees entered before December 31, 2018. Thus, for all existing divorce settlements and those entered by year-end, alimony will continue to be taxable/deductible.

Comments on the New Law

1. Window for Creative Use of Section 71 Payments— Because most alimony payers are typically in a considerably higher tax bracket than most payees, the tax saved by the payer usually exceeds the tax paid by the payee. This has set the stage for creative uses of “Section 71 payments” under which the disparity in tax brackets can be used to provide a tax subsidy.

Examples include using Section 71 payments to:

  • Divide non-qualified deferred compensation on a taxable/deductible basis.
  • Structure installment payments of a business buy-out of the non-owner spouse’s marital interest on a taxable/deductible basis.
  • Pay attorney fees on a taxable/deductible basis. However, after 2018, these opportunities and similar others will no longer be available. So, in situations where there is significant disparity in brackets, consider whether using Section 71 payments would be beneficial.

2. Fundamental Change in the Dynamic of Alimony/Spousal Support— When the alimony deduction was enacted in 1948, the theory was that, if a former family’s income is split between the parties in some manner post-divorce, the tax treatment should correspond.

As noted, the result in many cases has been less combined tax paid on the payer’s income. Because of budgetary concerns – including the enormous cost of 2017 TRA – eliminating the alimony deduction became a revenue raising option to help alleviate the deficit increasing effect of the TRA.

This creates a new paradigm for divorce practitioners and alimony guideline providers, that is, thinking in terms of aftertax dollars for spousal support, similar to child support.

3. Effect of Post 2018 Judgment Amendments— If a pre-2019 divorce or separation judgment or decree is amended on or after December 31, 2018, the new nontaxable/nondeductible law applies.

Query: Would this be the result even if the amendment does not pertain to spousal support? If the answer has not become clear by year-end, the distinct possibility of losing taxable/deductible status of spousal support payments must be considered before advising the post-2018 amendment of a pre-2019 judgment providing for taxable/deductible alimony.

Personal And Dependency Exemptions:

New Law

The federal personal and dependency exemption – $4,050 in 2017 for each taxpayer and each of his/her dependents – is repealed beginning in tax year 2018.

The $4,000 Michigan income tax personal and dependency exemption is based on the number of exemptions claimed on a taxpayer’s federal return. Thus, it too would be lost incident to the federal repeal. But, at the time this article is written, there is reason to believe that Governor Snyder will push legislation to preserve the Michigan exemption.

Comments on the New Law

1. Michigan Exemptions— Since the Michigan income tax personal and dependency exemptions are likely to be preserved, it still is advisable to specifically provide for who is entitled to the exemption for dependent children.

2. Need for a Michigan Form 8332?— As noted, the entitlement to Michigan exemptions has been tied directly to the number of exemptions claimed on a taxpayer’s federal return and there is no Michigan income tax provision allowing the custodial parent to release an exemption to the non-custodial parent.

Thus, it seems that, accompanying new Michigan law to preserve the exemption for state tax purposes, should be a provision allowing the release of the exemption from one parent to the other.

Perhaps by a Michigan counterpart to federal Form 8332, the execution of which has allowed for such releases for federal tax purposes.

Standard Deduction:

New Law

The standard deduction—used in lieu of itemizing deduction—was almost doubled under the 2017 TRA. For joint filers, it is $24,000 in 2018; single – $12,000; head of household – $18,000.

Comment on the New Law

Offset, More or Less, by Repeal of Exemptions— The benefit of the increased standard deduction is reduced, or eliminated, by the loss of personal and dependency exemptions.

Example:

For a family of 4 filing a joint return: Under TRA  Pre TRA
Standard Deduction $24,000 $13,000
Personal & Dependency Exemptions 0  16,200
Total Deduction $24,000  $29,200

The decrease in the total deduction is offset in part by the TRA’s lower tax rates (see below).

Miscellaneous Itemized Deductions:

New Law

Currently, certain expenses are deductible as miscellaneous itemized deductions to the extent they exceed 2% of adjusted gross income (AGI). Such expenses include tax preparation fees, investment advisory fees, unreimbursed employee expenses.

They also include attorney and accounting fees incurred in divorce that are attributable to (1) efforts to obtain spousal support and (2) tax advice.

Under the TRA, effective January 1, 2018, deduction of all such fees and expenses is eliminated.

Comment on the New Law

The deduction of a portion of divorce related fees has made them less expensive for clients who itemized deductions.

However, except for higher asset cases, more clients will be using the higher standard versus itemizing deductions.

New Tax Rates:

New Law

Tax rates have been, in the main, modestly reduced and are as follows effective January 1, 2018:

Taxable Income
Tax
Rates		 Single Married Filing
Jointly		 Head of
Household
10% 0-9,525 0-19,050 0-13,600
12% 9,526-38,700 19,501-77,400 13,601-51,800
22% 38,701-82,500 77,401-165,000 51,801-82,500
24% 82,501-157,500 165,001-315,000 82,501-157,500
32% 157,501-200,000 315,001-400,000 157,501-200,000
35% 200,001-500,000 400,001-600,000 200,001-500,000
37% Over 500,000 Over 600,000  Over 500,000

Comments on New Law

1. Lower Rates— The 7 tax rates ranging from 10% to 37% are 2%-3% lower than previous rates. For instance, a married couple with $75,000 of taxable income will pay $8,619 versus $10,297.

2. Tempered by Loss of Certain Deductions— The lower rates are offset, to varying degrees for different taxpayers, by the elimination of personal and dependency exemptions and loss of some itemized deductions.

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

About the Author:

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Highlights of 2017 Tax Reform Act’s Effects on Divorce”
View / Download February 2018 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “February 2018 : Highlights of 2017 Tax Reform Act’s Effects on Divorce”

June / July 2017 : Expediting the Business/Professional Practice Valuation Process

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

When a business or professional practice is involved in a divorce, there is often considerable difficulty and expense in determining a settlement value acceptable to both parties. This frequently is a major impediment to reaching settlement.

The fees to value a business or professional practice – and time required – can be significant, especially if two – or three – valuation experts are involved.

The following presents two methods to facilitate resolution of the valuation issue on a cost-effective, expeditious basis.

Abbreviated valuation analysis for mediation and/or settlement negotiations is often effective at providing a reliable value without “going the whole 9 yards” on the valuation process.

Essentially the business valuation expert performs a sufficient level of analysis to enable him/her to provide a reliable estimate of value–or range of values–for settlement purposes. The expert will provide well-footnoted valuation schedules and a summary report if requested.

The expert will generally be available for mediation to explain the valuation analysis.

The expert could be a “neutral” working on behalf of both parties; or, each party may hire an expert to perform an abbreviated valuation analysis. If the case is not resolved at mediation, the expert(s) can perform a more comprehensive analysis and report letter for trial or arbitration – generally with no duplication of effort.

Not all businesses are suitable for this approach. Some have too much uncertainty about the future such that an in depth analysis is required. However, based on the author’s experience, the abbreviated valuation approach applies to the vast majority of companies and professional practices.

If effective, this approach saves time and fees. The cost is generally about half the fee for a comprehensive valuation analysis and report.

Use of a neutral appraiser working on behalf of both parties is often an effective method for resolving the valuation issue on an expeditious, cost-effective manner.

It is common for each party to retain a business valuation expert. But, it is not uncommon that the values calculated by such experts are meaningfully different. If they cannot resolve the disparity in values, often a third expert is engaged to opine on value–causing considerable delay and additional fees.

However, if the parties can agree on one business appraiser at the outset, they can avoid the possible “battle of experts”. They can also save time, fees and emotion. Experienced family law practitioners know and can usually agree on a business appraiser with a reputation for competence and integrity.

When using a neutral, it is often advisable to reserve the right to have his/her valuation analysis reviewed for reasonableness by another expert. This offers some protection against a valuation analysis performed erroneously by the neutral. But, to preserve the benefits of using a neutral, the review should be limited to a “reasonableness check,” not a full-blown valuation analysis.

Example

(see PDF below for example details)
……

Continued in PDF file below… “Expediting the Business/Professional Practice Valuation Process”
View / Download June 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “June / July 2017 : Expediting the Business/Professional Practice Valuation Process”

April 2017 : Estimated Tax Payments; Tax Refunds / Overpayments

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

Estimated tax payments made–and/or taxes withheld – during the year of divorce may be a marital asset. Tax refunds, or overpayments applied to next year’s tax, attributable to tax payments made during marriage may also be a marital asset.

Or it may cut the other way–that is estimated tax payments and/or taxes withheld may be less than the actual tax on marital income received and shared during the year of divorce.

In this regard, note the following:

  1. Separate Returns for Year of Divorce – Whether divorcing parties can file a joint return or must file separate returns depends on their marital status as of December 31. If divorced as of that date, they must file separate returns for their respective separate incomes and deductions.
  2. Estimated Payments are Automatically Credited to the Husband – Since the husband’s social security number (SSN) is generally listed first on joint estimated payment vouchers (Form 1040ES) made during marriage, such payments will automatically be credited to him unless there is a written alternative provision agreed on by the parties.
     
    – The same applies to tax overpayments on the parties’ last joint return applied to the following year’s tax.
  3. Estimated Tax Payments and Taxes Withheld during Marriage are Marital Funds – Absent unusual circumstances, estimated tax payments and taxes withheld during marriage are made with marital money – essentially half by each party.

The above matters are often not addressed in divorce settlements. The following presents (1) observations on such tax payments and (2) applicable tax law.

Tax Payments Made during the Year of Divorce

Example – Assume the following alternative facts for joint estimated tax payments made by – and/or withheld on behalf of – H during the year of a divorce for which the judgment is entered on December 30.

[… Table with Example Data (see PDF below) …]

So, in Case #1, H will receive a windfall unless W’s attorney identifies the overpayment and makes an offsetting adjustment. Half of H’s $10,000 overpayment was made with W’s share of marital funds.
In Case #3, it is H’s attorney who needs to (1) identify that H will pay $10,000 of his own funds on income equally shared with W and (2) make an o setting adjustment. When paying the $10,000, H will, in effect, be paying both his and W’s $5,000 shares of the tax on marital income.

Agreement to Apportion Joint Estimated Tax Payments

IRS Publication 504 – “Divorced or Separated Individuals” – provides that divorced parties may agree on the division of joint estimated tax payments made during marriage.
……

Continued in PDF file below… “Estimated Tax Payments; Tax Refunds / Overpayments”
View / Download April 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “April 2017 : Estimated Tax Payments; Tax Refunds / Overpayments”

April 2015 : Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support

Posted by Joseph W. Cunningham, JD, CPA
Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

The following presents basic information on four federal income provisions relating to divorced or legally separated parents providing child support for one (or more) dependent child. These provisions (1) often provide significant tax savings – particularly to parties of modest means – and (2) are often overlooked by divorce counsel who can provide a valuable service by advising clients to check to see if they qualify for any of such tax benefits.

Dependency Exemptions General Rule

IRC Section 152(e) provides that if the parents, on a combined basis, (1) provide more than half a child’s support for the year and (2) have physical custody for more than half the year, then the parent having physical custody for more than half the year (the custodial parent) is entitled to the exemption.

The custodial parent may “release” the exemption to the other parent by executing a written waiver for (1) one year, (2) a specific number of years, or (3) all future years. IRS Form 8332 is the waiver that the custodial parent must execute to release the exemption. e non-custodial parent must attach the executed Form 8332 to his/her tax return for the year(s) for which the exemption has been released.

Other Aspects of the Dependency Exemption

  • The above applies to parents living apart for the last six months of the year as well as to divorced or legally separated parents.
  • “Physical custody” for more than half the year is deter- mined based on overnights. If overnights are equal, the parent with the higher adjusted gross income is deemed the custodial parent.
  • The waiver can be used to, effectively, provide that the parents will claim the exemption in alternating years.
  • Support provided by a parent’s new spouse, or his/her parents, is deemed provided by the parent.
  • The custodial parent may revoke the waiver by executing Part III of Form 8332. Such a revocation applies to the succeeding tax year.
  • The federal income tax exemption amount is $4,000 for 2015.

Phase-Out of the Tax Benefit of Personal and Dependency Exemptions

The tax benefit of personal and dependency exemptions is phased out for high income taxpayers.

The adjusted gross income (AGI) amounts at which the phase-out applies are as follows for 2015:
(Table shown in PDF below)

A taxpayer’s deduction for personal and dependency exemptions is reduced by 2% for each $2,500, or fraction thereof, that his/her AGI exceeds the above threshold amounts.

Example: A single individual has a $300,000 AGI. In addition to his personal exemption, his ex-wife has released the dependency exemption to him for their minor child who lives with her. The phase-out works as follows:

  • Two exemption deductions unreduced – 2 x $4,000 = $8,000
  • Number of $2,500 amounts, or a fraction there- of, by which AGI exceeds threshold – $300,000 – $258,2500/$2,500 = 17
  • Percent reduction in exemption deduction – 2% x 17 = 34%
  • Reduced exemption deductions – 100% – 34% = 66% x $8,000 = $5,280

Practice Pointers
…..

Continued in PDF file below… “Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support”
View / Download April 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “April 2015 : Four Federal Income Provisions Relating to Divorced or Legally Separated Parents Providing Child Support”