Tax Filing Tips

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”

December 2017 : House Ways and Means Committee Proposes “Tax Reform” Legislation that Provides (1) Alimony Would No Longer Taxable or Deductible and (2) Deductions for Personal Exemptions Would Be Eliminated. “Tax Cut and Jobs Act”, H.R. 1

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

by Joseph W. Cunningham, JD, CPA

In late October, 2017, the House Ways and Means Committee introduced the “Tax Cut and Jobs Act” (Act) which would, if enacted, provide sweeping changes to federal taxation of individuals and businesses. For the most part, if passed, the new provisions would take effect on January 1, 2018.

The Act has numerous, significant revisions to current tax law. The following are some of the most notable for family law practitioners.

Alimony Proposal

As noted, among the many changes in the Act is the provision that spousal support payments would be non-deductible / non-taxable, similar to the treatment of child support payments. This would apply to divorce judgments and separation agreements executed after 2018, and to any such documents amended after 2018 which expressly provide for tax treatment under the Act to apply.

Comments on the Alimony Proposal

Tax Subsidy Eliminated

Often the spousal support payer is in a meaningfully higher tax bracket than the payee spouse. This affords the opportunity to obtain a “tax subsidy” from Uncle Sam. For example, if W, the payer, is in a 40% federal tax bracket and H is in a 20% bracket, it costs Uncle Sam twenty cents on the dollar of spousal support paid:

[View Table in PDF file below]

Under the Act, such tax subsidies would no longer be available.

Advantageous Use of Section 71 Payments Also Eliminated

When there is a significant disparity in brackets, what have become known as Section 71 payments have often provided an effective, tax saving tool when structuring:

  1. A buy-out of one spouse’s marital interest in the other’s business or professional practice.
  2. A division of non-qualified retirement or executive benefits for which a QDRO cannot be used.
  3. A payment of the other spouse’s professional fees on a tax deductible basis.
  4. A “global” settlement taking advantage to the bracket disparity.

These and other uses of Section 71 payments would be unavailable under the Act.

Planning Consideration

As noted, the current taxable/deductible tax treatment of spousal support can be used to advantage. If such is the case and subject divorce is in a position to conclude before yearend, consider the merits of doing so.

Other Selected Highlights of Proposed Changes

Individual Tax Changes

  • Tax Brackets—The current 7 tax brackets ranging from 10% to 39.6% would be replaced by 4 brackets – 12%, 25%, 35%, and 39.6%. The top bracket would apply taxable income of singles exceeding $500,000, and marrieds’ taxable income over $1,000,000.
  • Alternative Minimum Tax (AMT)—Eliminated
  • Deduction for Personal Exemptions—Eliminated.
  • Standard Deduction—Increased substantially – $12,000 for single; $18,000 for single with qualifying child; $24,000 for married.
  • Certain Itemized Deductions Eliminated—State & local income taxes; medical expenses; casualty losses; tax preparation fees; unreimbursed business expenses; all interest expense except for mortgage interest on principal residence.
  • Child Tax Credit—Increased from $1,000 to $1,600.

Business Tax Changes

  • Tax Brackets— Corporate tax rate would be a flat rate of 20%; 25% for personal service corporations.
  • Alternative Minimum Tax (AMT)—Eliminated
  • “Pass-Through” Entities—Generally, the tax rate on S Corporation and LLC pass-through income would be 25% on 30% of the income; the balance of 70% – subject to individual tax rates.

Will the Act Become Law?

The Senate Finance Committee will next prepare its version of the tax reform bill. Then a Joint Conference Committee will iron out differences and the resulting bill will be presented to the House and Senate for approval.

Due to the failure to enact any significant GOP platform item to date, there will be considerable pressure to pass tax
reform legislation this year. The House bill provides a foundation for moving it forward.

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… “House Ways and Means Committee Proposes “Tax Reform” Legislation that Provides (1) Alimony Would No Longer Taxable or Deductible and (2) Deductions for Personal Exemptions Would Be Eliminated. “Tax Cut and Jobs Act”, H.R. 1”
View / Download December 2017 Article – PDF File

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

Read More “December 2017 : House Ways and Means Committee Proposes “Tax Reform” Legislation that Provides (1) Alimony Would No Longer Taxable or Deductible and (2) Deductions for Personal Exemptions Would Be Eliminated. “Tax Cut and Jobs Act”, H.R. 1”

January 2017 : 2017 Federal Income Tax Rates & Brackets, Etc., Selected IRS Publications, and Attorney “Tax Deduction” Letters

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

by Joseph W. Cunningham, JD, CPA

Excerpt:

In Rev. Proc. 2016-55 (IRB 2016-45), the IRS released the 2017 tax rates applicable to taxable income of taxpayers ling tax returns as single, married filing jointly, or head of household.

[TABLE INCLUDED IN PDF FILE]

Standard Deduction

  • Single … $6,350; $7,900 if 65 Years Old
  • Married Filing Jointly … $12,700; $13,950 if One Spouse is 65, $15,200 if Both Are 65
  • Head of Household … $9,350; $10,900 if 65

Personal Exemption

The personal exemption for 2017 is $4,050. However, 2% of the personal exemption is “phased out” – or reduced – for each $2,500, or part of $2,500, if a taxpayer’s adjusted gross income (AGI) exceeds the statutory threshold for subject filing status, as follows:

[TABLE INCLUDED IN PDF FILE]

Long-Term Capital Gain Rates

  • 0% for taxpayers in the 10% or 15% brackets.
  • 15% for:
    • Single Filers with taxable income between $37,950 and $416,700
    • Married Filing Jointly with taxable income between $75,900 and $470,700
    • Head of Household with taxable income between $50,800 and $444,550
  • 20% for taxpayers with taxable incomes exceeding the high end of the above ranges

Selected IRS Publications
……

Continued in PDF file below… “2017 Federal Income Tax Rates & Brackets, Etc., Selected IRS Publications, and Attorney “Tax Deduction” Letters”
View / Download January 2017 Article – PDF File

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

Read More “January 2017 : 2017 Federal Income Tax Rates & Brackets, Etc., Selected IRS Publications, and Attorney “Tax Deduction” Letters”

December 2016 : Nontaxable/Nondeductible Designation of Payments

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

by Joseph W. Cunningham, JD, CPA

Excerpt:

General

A question put to me recently was, essentially – Can payments that may qualify as taxable/deductible be stipulated as nontaxable/nondeductible with assurance they will be so treated for tax purposes?

The answer is “yes”, pursuant to IRC 71(b)(1)(B). Just as it is important to include a “tax intent” provision when payments are intended to be taxable/deductible, the same is advisable when they are intended to be nontaxable/nondeductible. Tax intent provisions prevent misunderstandings down the road. Sometimes a tax preparer may suggest payments are deductible by the payer when such was not intended. A tax intent provision prevents this.

The following is sample generic language for a nontaxable/nondeductible tax intent provision:

“Defendant’s payments of [property/spousal support] to Plaintiff provided in paragraph [ ] are hereby designated by the parties, pursuant to IRC Section 71(b)(1)(B), as not includable in Plaintiff’s income under IRC Section 71 and, correspondingly, not deductible by Defendant under IRC Section 215. Plaintiff and Defendant agree that neither will file an income tax return on which subject payments are reported inconsistently with their expressly designated nontaxable/nondeductible status.”

Other Uses

Lump-Sum Payable on Death of Payer — The nontaxable/ nondeductible designation can be used to ensure that payments of life insurance proceeds or a lump-sum settlement from the estate of a deceased spousal support payer, which is not deductible as alimony on an estate’s income tax return, will not be taxable to the payee. This prevents the possibility of one party being taxed on a sizable payment for which there is no corresponding deduction by the other’s successor-in-interest.

It is common after the death of an alimony payer to con- vert the balance of the obligation to its lump-sum, present
value, after-tax equivalent (using the payee’s tax rate) and pay it in full with insurance proceeds. The nontaxable designation accommodates this practice.

Lump-Sum Payable for Other Reasons
……

Continued in PDF file below… “Nontaxable/Nondeductible Designation of Payments”
View / Download December 2016 Article – PDF File

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

Read More “December 2016 : Nontaxable/Nondeductible Designation of Payments”