There’s nothing easy about divorce, and President Joe Biden‘s latest proposal may deliver a tax surprise to couples calling it quits.
Biden wants higher taxes on the wealthiest 1% to help fund education, paid leave, childcare and other social programs, impacting those earning over $400,000.
The proposal calls for raising the highest income tax rate to 39.6%, a hike from the current 37%.
Top earners may also pay nearly double on long-term capital gains, with an increase to 39.6% from 20%, not including the 3.8% Obamacare surcharge.
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“The repercussions of Joe Biden’s proposed tax plan are pretty significant,” said certified financial planner Stacy Francis, president and CEO of Francis Financial in New York City.
Without strategic planning, the tax impacts may be drastic for divorcees, she said.
Fewer assets to split
One of the biggest challenges for divorcees is paying for two households.
Higher taxes means less cash flow to cover living expenses, said Aviva Pinto, managing director at Wealthspire Advisors in New York City.
“We see that after divorce, for men and women, the standard of living plummets,” said Francis.
One spouse may have to sell the assets received in the divorce settlement to make ends meet, possibly triggering tax issues.
For example, let’s say one spouse sells a $500,000 portfolio with significant gains from the past 15 years.
The sale will greatly increase that spouse’s annual income, and may expose profits to Biden’s proposed 39.6% capital gains rate, Pinto said.
The proposed tax changes may also impact home transfers, said Eric Toya, a CFP and partner at Navigoe in Redondo Beach, California.
For example, let’s say a divorcing couple bought a home decades ago in California for $250,000, and the property is now worth $1.7 million.
If the couple sells while married, they may qualify for a $500,000 tax break on the profit. But if one spouse sells it post-divorce, they may only get a $250,000 tax write-off.
“It’s one of those things that a lot of divorcing couples don’t think about,” said Toya.
Moreover, if that spouse sells the property for $1.7 million, they may push their annual income over $1 million, risking the higher tax rates on part of their home profit.
Combined with state taxes, the top capital gains rates could be over 50% in California, according to the Tax Foundation.
Tips for divorcees
While the future of Biden’s proposals is unknown, Pinto said couples planning to split may consider finalizing their divorce before the new laws go into effect.
“Don’t let it drag on,” she said. “A lot of the courts are just opening, and there’s a huge backup.”
Divorcees also need to plan for the post-tax impacts of property transfers, such as investment portfolios or homes. They may need to consider the tax bite, especially for assets with significant gains, Pinto said.
“Fight for cash,” she recommends.
After divorce, a newly single investor often needs changes to their investment portfolio, said Francis.
Those looking to swap out investments may dodge higher taxes on profits by making changes before the new laws, she said.
“So many times, people are just looking for the finish line of the divorce,” Francis said. “They don’t think about how they’re going to navigate their life afterward.”