Divorce entails difficult personal issues, and taxes are probably the farthest thing from your mind. However, several tax concerns may need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are six issues to be aware of if you’re in the process of getting a divorce.

1. Personal residence sale 

In general, if a couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (as long as they’ve owned and used the home as their principal residence for two of the previous five years). If one former spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect this tax exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

2. Pension benefits

A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a “qualified domestic relations order” (QDRO). This gives one former spouse the right to share in the pension benefits of the other and taxes the former spouse who receives the benefits. Without a QDRO, the former spouse who earned the benefits will still be taxed on them even though they’re paid out to the other former spouse.

3. Filing status

If you’re still married at the end of the year, but in the process of getting divorced, you’re still treated as married for tax purposes. We’ll help you determine how to file your 2024 tax return — as married filing jointly or married filing separately. Some separated individuals may qualify for “head of household” status if they meet the requirements.

4. Alimony or support payments

For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the former spouse making them. And the alimony payments aren’t included in the gross income of the former spouse receiving them. (The rules are different for divorce or separation agreements executed before 2019.) This was a change made in the Tax Cuts and Jobs Act. However, unlike some provisions of the law that are temporary, the repeal of alimony and support payment deduction is permanent.

5. Child support and child-related tax return filing

No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying former spouse (or taxable to the recipient). You and your ex-spouse will also need to determine who will claim your child or children on your tax returns in order to claim related tax breaks.

6. Business interests 

If certain types of business interests are transferred in connection with divorce, care should be taken to make sure “tax attributes” aren’t forfeited. For example, interests in S corporations may result in “suspended” losses (losses that are carried into future years instead of being deducted in the year they’re incurred). When these interests change hands in a divorce, the suspended losses may be forfeited. If a partnership interest is transferred, a variety of more complex issues may arise involving partners’ shares of partnership debt, capital accounts, built-in gains on contributed property and other complex issues.

A range of tax challenges

These are just some of the issues you may have to cope with if you’re getting a divorce. In addition, you may need to adjust your income tax withholding, and you should notify the IRS of any new address or name change. There are also estate planning considerations. We can help you tackle the financial issues involved in divorce.

© 2024

The current estate tax exemption amount ($13.61 million in 2024) has led many people to feel they no longer need to be concerned about federal estate tax. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it. But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Important: Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Of course, Congress could act to extend the higher amount or institute a new amount.

Here are some strategies to consider in light of the current large exemption amount.

Using the annual exclusion 

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility 

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

If you want to discuss estate planning or income tax saving strategies, contact us.

© 2024

If you own a closely held corporation, you can borrow funds from your business at rates that are lower than those charged by a bank. But it’s important to avoid certain risks and charge an adequate interest rate.

Basics of this strategy

Interest rates have increased over the last couple years. As a result, shareholders may decide to take loans from their corporations rather than pay higher interest rates on bank loans. In general, the IRS expects closely held corporations to charge interest on related-party loans, including loans to shareholders, at rates that at least equal applicable federal rates (AFRs). Otherwise, adverse tax results can be triggered. Fortunately, the AFRs are lower than the rates charged by commercial lenders.

It can be advantageous to borrow money from your closely held corporation to pay personal expenses. These expenses may include your child’s college tuition, home improvements, a new car or high-interest credit card debt. But avoid these two key risks:

1. Not creating a legitimate loan. When borrowing money from your corporation, it’s important to establish a bona fide borrower-lender relationship. Otherwise, the IRS could reclassify the loan proceeds as additional compensation. This reclassification would result in an income tax bill for you and payroll tax for you and your corporation. (However, the business would be allowed to deduct the amount treated as compensation and the corporation’s share of related payroll taxes.)

Alternatively, the IRS might claim that you received a taxable dividend if your company is a C corporation. That would trigger taxable income for you with no offsetting deduction for your business.

Draft a formal written loan agreement that establishes your unconditional promise to repay the corporation a fixed amount under an installment repayment schedule or on demand by the corporation. Take other steps such as documenting the terms of the loan in your corporate minutes.

2. Not charging adequate interest. The minimum interest rate your business should charge to avoid triggering the complicated and generally unfavorable “below-market loan rules” is the IRS-approved AFR. (There’s an exception to the below-market loan rules if the aggregate loans from a corporation to a shareholder are $10,000 or less.)

Current AFRs

The IRS publishes AFRs monthly based on market conditions. For loans made in July 2024, the AFRs are:

• 4.95% for short-term loans of up to three years,
• 4.40% for mid-term loans of more than three years but not more than nine years, and
• 4.52% for long-term loans of over nine years.

These annual rates assume monthly compounding of interest. The AFR that applies to a loan depends on whether it’s a demand or term loan. The distinction is important. A demand loan is payable in full at any time upon notice and demand by the corporation. A term loan is any borrowing arrangement that isn’t a demand loan. The AFR for a term loan depends on the term of the loan, and the same rate applies for the entire term.

An example

Suppose you borrow $100,000 from your corporation with the principal to be repaid in installments over 10 years. This is a term loan of over nine years, so the AFR in July would be 4.52% compounded monthly for 10 years. The corporation must report the loan interest as taxable income.

On the other hand, if the loan document gives your corporation the right to demand full repayment at any time, it’s a demand loan. Then, the AFR is based on a blended average of monthly short-term AFRs for the year. If rates go up, you must pay more interest to stay clear of the below-market loan rules. If rates go down, you’ll pay a lower interest rate.

Term loans for more than nine years are smarter from a tax perspective than short-term or demand loans because they lock in current AFRs. If rates drop, a high-rate term loan can be repaid early and your corporation can enter into a new loan agreement at the lower rate.

Avoid adverse consequences

Shareholder loans can be complicated, especially if the loan charges interest below the AFR, the shareholder stops making payments or the corporation has more than one shareholder. Contact us about how to proceed in your situation.

© 2024

Buckle up, America: Major tax changes are on the horizon. The reason has to do with tax law and the upcoming elections.

Our current situation

The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made sweeping changes. Many of its provisions are set to expire on December 31, 2025.

With this date getting closer each day, you may wonder how your federal tax bill will be affected in 2026. The answer isn’t clear because the outcome of this November’s presidential and congressional elections is expected to affect the fate of many expiring provisions. A new political landscape in Washington could also mean other tax law changes.

Corporate vs. individual taxes

The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers, with the highest tax rate reduced from 39.6% to 37%. But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. Tax legislation could still change the corporate tax rate.)

In addition to lowering rates, the TCJA revised tax law in many other ways. On the individual side, standard deductions were increased, significantly reducing the number of taxpayers who benefit from itemizing deductions for certain expenses, such as charitable donations and medical costs. (You benefit from itemizing on your federal income tax return only if your total allowable itemized write-offs for the year exceed your standard deduction.)

In addition, through 2025, certain itemized deductions are eliminated. Others are more limited, including those for home mortgage interest and state and local tax (SALT).

For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships.

The expiring provisions will affect many taxpayers’ tax bills in 2026, unless legislation extending them is signed into law.

Possible scenarios

The outcome of the presidential election in less than five months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four possible scenarios:

1. All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
2. All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
3. Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
4. Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.

How your tax bill will be affected in 2026 will partially depend on which one of these scenarios becomes reality and whether your tax bill went down or up when the TCJA became effective back in 2018. That was based on a number of factors including your income, your filing status, where you live (the SALT limitation negatively affects more taxpayers in certain states), and whether you have children or other dependents.

Your tax situation will also be affected by who wins the presidential election and who controls Congress. Democrats and Republicans have competing visions about how to proceed when it comes to taxes. Proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).

The tax horizon

As the TCJA provisions get closer to expiring, it’s important to know what might change and what tax-wise moves you can make if the law does change. We’ll keep you informed about what’s ahead. We’re here to answer any questions you may have.

© 2024