Over the past year, marriage lawyers have reported an increase in the number of clients seeking divorce information. Additionally, Internet searches for divorce-related keywords increased 11%, with nearly twice as many people searching for “an online divorce record” and 14% more typing “I want a divorce.” From the start, according to data analytics company SEMrush. of COVID. These divorcing couples report spending most of 2020 locked up together, 24/7, revealed deep cracks in their marriage.
Now married couples face even stronger headwinds against staying together. The tax proposal just released by the House Ways and Means Committee on September 13 provides a glimpse of what the bill might look like in its final form. While there are many tax changes, the most notable include increasing income tax rates and capital gains on high incomes, especially married couples. Married people will suffer the most dramatic tax cuts, so divorce could save high-income couples thousands of dollars or more in taxes.
The bill includes the reinstatement of the top marginal rate of 39.6% and a series of new tax increases for singles earning $ 400,000 or married couples earning $ 450,000. Right now, the top marginal tax rate is 37%, which kicks in when individuals earn more than $ 523,600 per year and couples earn more than $ 628,300, resulting in this called the “marriage penalty”.
The American Families Plan proposal amplifies the marriage penalty that comes into play when taxes paid by a couple exceed what they would have paid had they remained single with the same income. The marriage penalty is not a new concept, but the Biden plan increases the tax burden. If you look at the tax brackets proposed in the recently released “Green Paper,” which is the updated version of Biden’s tax plan, you will notice that the brackets for joint filing of marriages (income over $ 509,300) are now $ 56,500 more than single tax filers (incomes over $ 452,700) before they fall into the top regular tax rate of 39.6%. This will create a significant tax burden for married couples, making divorce more financially attractive now.
For example, two single tax filers earning $ 400,000 would end up in the 35% tax bracket. If these same two people were married and filed as “Married, jointly filing”, their total income would be the same at $ 800,000. However, $ 290,700 of that income would be taxed at the highest rate of 39.6%, resulting in thousands of dollars in additional taxes.
The House Ways and Means Committee proposal calls for long-term capital gains tax rates to also drop from 20% to 25% for people earning $ 400,000 and married couples earning $ 450,000, once again enacting a severe marriage penalty. This 25% rate would be the highest maximum rate imposed on long-term capital gains over the past 25 years.
To save on taxes, will financial advisors recommend couples increase their savings for their children’s college education, maximize their 401 (k) s work… and divorce? Avani Ramnani, managing director of Francis Financial and specialist in divorce finance, explains that she is not recommended to clients to divorce because of taxes. However, Ramnani shares that “if the couple are already in the process of a divorce, it makes sense to make them aware of the tax savings they could achieve if they complete their divorce sooner rather than later.”
Seth Kamens, CPA and managing member of the accounting firm Feder Kamens, warns that getting divorced for tax reasons alone is not a good idea. Kamens shares that “Income Decision 76-253 states that the IRA will ignore a divorce obtained only to save money on taxes. The couple have to recalculate their taxes as if they had been married all year, making the couple not only liable for additional taxes but also interest and penalties. Couples exceeding the threshold may also consider filing their taxes separately, but often useful tax deductions and credits are denied. “
While the ink on the bill is still not dry, experts like Kamens and Ramnani agree that couples should discuss their tax strategy as soon as possible. The changes in tax brackets are not expected to take effect until 2022 at the earliest, giving couples time to plan. However, the increase in the capital gains rate can take effect immediately. This means that people with significant unrealized capital gains not avoid the higher tax rate by selling these assets before the end of 2021.
Ramnani recommends that couples reduce their taxable income by maximizing their workplace retirement plans and participating in employer-sponsored savings accounts for childcare and health care. It would also be wise to talk to your financial advisor about harvesting tax losses with your investments.
Workers with 401 (k) or 403 (b) pension plans can make pre-tax contributions up to a maximum of $ 19,500 ($ 26,000 for those 50 and over). the added benefit of increasing retirement investments.
A Flexible Spending Account (FSA) can also save you money because it allows you to pay for unreimbursed medical bills with pre-tax dollars. An employee can contribute up to $ 2,750 in plan year 2021.
A health savings account (CSH) allows pre-tax contributions to be used for health care costs not covered by insurance. However, this account is only available to employees with a high deductible health insurance plan. Contribution limits can reach $ 3,600 for individuals and $ 7,200 for families for 2021.
Ramnani adds, “Both HSAs and FSAs anticipate a reduction in tax bills in the years in which contributions are paid, making them sound opportunities for tax savings. ”