Divorce can be a complicated and emotional process, and often even more so when it involves high net worth individuals. Enter the Massachusetts “millionaire’s tax,” a new and daunting tax hurdle for people with complicated assets and compensation. Because it applies to all types of income, including investment income and capital gains tax, the division of marital property during a divorce requires increased agility and attention to detail when surveying the tax consequences of marital property division.
What’s more, family law practitioners will have to consider the Massachusetts SJC’s decision in Cavanagh v Cavanagh, which made some major changes to the way that alimony and child support is calculated, on top of extending the forms of income considered for the purpose of child support to include employer retirement contributions and income from investments. Marital property division will also be subject to the recent Tax Cuts and Jobs Acts shakeup, which leaves the payor of alimony no longer able to deduct alimony from their federal tax bill as well as their Massachusetts state tax returns.
All these developments could potentially mean that the payor of alimony and/or support could end up with a reduced net income compared to the lower earning spouse after support is paid. So, what exactly is the Massachusetts millionaire’s tax, and in what ways could it impact a divorce with complex assets?
The Massachusetts Millionaire’s Tax is a 4% tax increase on individuals with annual incomes over $1 million. The tax applies to all types of taxable income, including wages, capital gains, dividends and interest. The following are a couple of ways it could impact your divorce:
Property Division and the Timing of the Sale of Assets
When people get a divorce they may sell real estate like the family home or holiday homes. They may also sell a business or cash in retirement savings to pay for the divorce and/or provide liquidity to buy out their spouse’s share of assets. The sudden influx of cash from the sale of a home or a business for example could cause a temporary bump in income that could put a marital estate at risk of major tax consequences due under the new laws. This is particularly true for the sale of assets like second homes, which don’t have the capital gains tax advantage of the primary residence.
High net worth individuals may need to consider the tax implications of selling or transferring assets during or after the divorce process, and may need to adjust their plans accordingly. High net worth spouses who have received an unexpected windfall like an inheritance should be especially mindful of the potential tax hit to their marital estate. Divorcing spouses may need to consider strategies like filing separately before their divorce is finalized, spreading out the division of assets throughout more than one tax year, giving assets to children and evaluating the tax structure of any trusts that can be assessed under state tax law. Each individual situation is different and you should consult your high level divorce team, including your divorce attorney-mediator.
Alimony and Child Support
Another potential impact of the Massachusetts Millionaires tax on high net worth divorce cases is that it could lead to changes in alimony and child support payments. This is because the tax would reduce the net income of high net worth individuals, making it more difficult for them to meet their financial obligations in addition to their support obligations.
Under current Massachusetts law, alimony payments are based on the income of both parties, with the higher earning spouse typically paying a larger percentage of their income in alimony. As a result of the Massachusetts Millionaires tax, high net worth individuals could see a reduction in their net income. Support is calculated using the parties’ gross incomes, but where there are much higher tax rates associated with the payor’s income it is important to work with an attorney who understands how to properly present the tax consequences to the Court in order to seek lower alimony payments and reduced child support payments. As mentioned, the recent TCJA changes get rid of the tax advantage of alimony to the payor.
Greater scrutiny of assets
Added to the increased tax burden of the Mass millionaires tax, higher earning spouses and non-custodial parents could face a more rigorous test in the family courts to establish alimony and child support post Cavanagh v Cavanagh. Cavanagh v Cavanagh requires courts to consider the income of both parties to concurrently establish alimony and child support, taking into consideration each parent’s financial and tax obligations and allowing the court to consider previously off-limits forms of incomes for child support such as employer 401K matches, interests and dividends.
Because the courts will be moving toward a more rigorous test to scrutinize the incomes and tax obligations of divorcing spouses and parents, the Mass millionaire’s tax makes this calculation more onerous. This is one more reason why high net worth individuals may want to step back from litigation and choose high level divorce mediation or collaborative divorce as a more discreet and efficient process for reaching a settlement.
There is no doubt that the impact of the Massachusetts millionaire’s tax will be felt by people embarking on a high asset, complex divorce. Taken in combination with other changes to federal tax law and Massachusetts divorce law, family law practitioners will need to offer clients an overhauled assessment of the potential of their property division, foregrounding the need to balance support and alimony with the tax obligations of both spouses. If you are considering a divorce from a high earning spouse, and/or your combined net worth could put you at risk of a high tax penalty, please don’t hesitate to reach out to our highly qualified Massachusetts divorce attorneys and attorney mediators. At Mansur Law Group we assess your finances and marital property and offer tailored solutions which can help you avoid litigation if that is the desired path. Please contact us to learn more about our Massachusetts divorce team.