How Biden’s Tax Plan Will Affect Divorced People

An often-overlooked aspect of getting a divorce is handling the financial repercussions after the division of assets. There’s a large difference between a married couple’s income and the income and assets of a newly single adult. Depending on your financial situation before and after the divorce, the separation process can potentially decrease – or increase – your obligations come tax season.

With a new president-elect, taxes look like they will only get more complicated, particularly for high-earning individuals. Joe Biden’s tax plan has some specific changes and increases that may raise taxes specifically for high-income groups.

These tax plans need to pass through the House and Senate to be approved, so nothing is set in stone. It’s possible that these tax changes could go into effect as soon as 2021, though, so it’s a good idea to learn about them before they affect you for better or worse.

So, what’s changing? Let’s take a look at president-elect Biden’s proposed tax adjustments.

Increased Top Marginal Tax Bracket

Biden is insistent that taxes will not change for people making less than $400,000 yearly. However, people and couples making more than $400,000 annually will be in for a tax increase. Under Biden’s plan, the top marginal tax bracket will return to where it was before the 2017 Tax Cuts and Jobs Act.

The current tax brackets include a top marginal bracket of 37%, which only kicks in when individuals make more than $500,000 annually, and couples more than $600,000. Biden’s plan would raise that bracket to 39.6% and lower the threshold to just above $400,000 for individuals and $475,000 for couples.

Depending on how you and your spouse’s combined income can be broken down, a divorce may make more of your income vulnerable to this bracket increase. On the other hand, divorcing could make this change entirely irrelevant if your individual income drops below $400,000.

Increased Social Security Tax

Income tax isn’t the only place where your yearly salary could be taxed. Biden’s plan would also remove a limit on the amount one person or couple must contribute to Social Security each year.

Historically, Social Security taxes, which are a part of payroll taxes, have been limited to apply only to wages below $137,700 per year. Biden’s plan would add additional Social Security taxes to all payroll income above $400,000. This would create a “donut hole” where income between $137,700 and $400,000 would not be taxed for Social Security.

This leads to another situation where a divorce may positively or negatively affect your tax burden. If your divorce drops your yearly income below $400,000, this change will not affect you. On the other hand, it will add a further tax burden if your income remains above $400,000.

Long-Term Capital Gains

High-asset divorces often involve the division of investment accounts and other assets that generate capital gains. These accounts and assets may be seriously affected by Biden’s tax plan. Under his plan, tax rates on long-term capital gains and qualified dividends would rise from 20% to 39.6% for people with income over $1 million.

The intention is to tax capital gains the same way other income is taxed. Currently, the 20% cap applies to all long-term capital gains for people earning more than $441,451 yearly or couples earning more than $496,601. The new rate would apply to long-term capital gains for individuals and couples earning more than $1 million, so a divorce may prevent that from ever affecting your finances.

Tax Deductions

Itemized deductions can help trim a significant amount of the tax burden for high-income couples and individuals. However, Biden’s plan would cut the amount that people making more than $400,000 could claim as itemized deductions. Over that income threshold, itemized deductions would be limited to 28% of their value, rather than the potentially higher value of their respective tax bracket.

Since itemized deductions can include expenses like interest, personal property taxes, donations, and unreimbursed business expenses, that cap may seriously affect high-income individuals after a divorce.

Estate and Gift Tax Exemption

While estate and gift taxes aren’t applicable every year, they may be important to you if you have children with your spouse. Biden’s tax plan would lower the estate and gift tax exemption to just $3.5 million, down from over $11 million. It would also remove the “step-up” for inherited assets upon death. If you’re planning ways to support your children after a divorce, these two changes may seriously affect your financial plan.

What Won’t Change

Of course, some things won’t change under Biden’s plan. He has stated explicitly that he doesn’t intend to raise taxes on those who earn less than $400,000. There are a few things that will stay the same:

Marginal tax rates below $400,000 annually will stay exactly as they are. For people and couples earning less than this amount, their tax burden won’t change – positively or negatively.

Similarly, alimony deductions will continue to be treated the way they have been since 2019. This means that the payer will not be able to deduct them and the payee will not need to include them on their taxes.  

Finally, child custody deductions will remain the same. The custodial parent will be able to use the child tax credit, while the non-custodial parent will not unless both parents file specific waivers.

Protect Your Assets – Work with Professionals

There’s never a perfect time to divorce, financially, politically, or otherwise. However, the current political situation in the US has certainly made the financial situations of high-income couples more complicated. While there’s no guarantee that Joe Biden’s tax plan will be approved, it seems likely that at least aspects of it are signed into law in the next few years. That could seriously impact your finances if you’re anticipating a divorce.

If you’re considering a high-asset divorce, then you should reach out to a qualified high-net-worth divorce attorney. At Kaspar & Lugay LLP, we have years of experience navigating the process of divorcing with significant assets. Contact us today to discuss your options and find out how a divorce may affect your taxes.

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