Divorces During Hard Economic Times

With a Democratic president and a larger Democratic majority in Congress, we have already seen significant changes in tax laws and federal legislation affecting different aspects of our lives. What will these new laws mean for our divorcing clients and how should our clients change their legal strategies in anticipation of these new laws?

Tax Issues

First, lawyers can anticipate that their higher-income clients ' those with incomes over $250,000 ' may eventually, not right away, pay higher taxes; perhaps 40% to 44% could be the top tax rate. Individuals earning less than $250,000 will pay fewer taxes. For middle-income families, lower taxes for everyone will mean that the after-tax impact of alimony payments will be less significant and a less important consideration in our negotiations. For high-income families, where the breadwinner is earning in excess of $250,000 and there has been a stay-at-home parent, the possible future increased tax effect is going to be significant.

A property settlement agreement negotiated on 2008 net tax income, fixing alimony based on those figures, could result in a real squeeze if the breadwinner's net income is substantially reduced by rising taxes. Such an arrangement could create a windfall for the parent receiving alimony if her taxes on that money are less.

Thus, starting immediately in anticipation of changes, lawyers representing the chief breadwinner should consider making alimony adjustable from year to year based on the payor's net income. If one is representing the stay-at-home parent, of course, such considerations may not be to his/her advantage, and immediately locking in alimony would be beneficial.

If the parties have substantial dividend or capital gains income, those assets may, in the future, be taxed at a higher rate to repay the government debt created by the bailout. There has been conjecture that capital gains rates will go up to 20% and dividend rates could go up as high as 40%. These considerations are important in valuing options and choosing the overall method of distribution in a case.

It is the usual practice with options to divide them evenly in half and have them distributed net of tax after exercise. This practice should absolutely be the rule in the future. Fluctuating future tax rates will make present offsets “asset swaps” risky.

Given the recession, some options that have been granted may never be above water, especially in the financial and insurance industries. Increased tax rates on capital gains may render options that do have value less valuable. The fluctuations relating to the changes in the capital gains rates can be shared by both parties, if options are divided between the parties net of tax, after exercise.

Regulation May Change the Rules

Government policy will ultimately impact our clients in various ways, depending on the industry in which the breadwinner works. We have already seen that breadwinners in financial and insurance industries have suffered greatly. Management in those industries have stockholdings that have gone down dramatically, in some cases as much as 90%. The policy of the Federal Reserve and the government has everything to do with the survival of our financial institutions and insurance companies such as AIG.

On the other hand, lawyers should be mindful and anticipate the possible negative consequences of future government action under Democratic Congresses for breadwinners who work in the pharmaceutical industry and managed care. It is probable that a Democratic Congress will legislate for government-negotiated prices on Medicare-provided drugs and otherwise squeeze the pharmaceutical industry, as well as regulate managed-care providers to the benefit of the taxpayers, but not those industries' employees and shareholders.

Which Assets Will Be Best?

When one person has had a large proportion of the marital estate distributed to them in the form of one particular asset class or a single stock in a company that has declined in value, it can be anticipated that they will end up with the proverbial short end of the stick. It would be bad representation for lawyers to negotiate disproportionate distribution of stock in companies that they think may have trouble in the future.

Consideration of asset classes within equitable distribution will be important in the future, just as it is as a portfolio management tool. Thus, selling the family residence may be advisable, if retaining the residence would result in one party owning mostly real estate and the other party owning mostly stock and retirement assets. No one really knows which asset classes ' real estate or equities ' will bounce back first and bounce back the hardest.

Bankruptcy Factors

Finally, we can anticipate that the bankruptcy laws may change. The latest proposal for the rescue of the residential mortgage market would permit the government, and possibly even the courts, to change the terms of mortgages and forgive the amount of a mortgage that is over the value of the residence serving as collateral. Homeowners will also be able to reduce interest, or lengthen the term of a mortgage.

Ironically, the bankruptcy laws that were passed recently helped creditors in that they restricted Chapter 7 discharges and forced debtors into Chapter 13 workouts. In a recession it will be interesting to see whether or not the federal government will liberalize the availability of Chapter 7 discharges. Whether or not they liberalize the availability of Chapter 7 discharges, all divorce lawyers in this recession context should be aware of the debtor counseling requirements and services which are available under the new bailout proposals and the bankruptcy laws, as many of our clients will need those services. Joint compliance with a program to retire debt may be a critical component of future property settlement agreements.

Conclusion

Divorce lawyers often feel helpless in the face of clients who have dug themselves into deep financial holes or are innocent victims of the recession. This year will be one of rapid legislative change. It will keep all lawyers on their toes. For instance, tax credits will provide a significant tax benefit for new home purchasers after separation, and it will need to be attributed to the purchaser receiving the benefit.

Lawyers will have to constantly re-examine the advice that they give their clients and adjust their assumptions in addition to helping them to get out of their marriages, as well as out of debt.

Elizabeth L. Bennett is the founder of the family law firm Bennett & Associates in Wayne, PA, and co-founder of the Collaborative Family Law Affiliates. She is a former partner at Dilworth Paxson and a frequent speaker on divorce law-related issues. This article first appeared in The Legal Intelligencer, an Incisive Media sister publication of this newsletter.

With a Democratic president and a larger Democratic majority in Congress, we have already seen significant changes in tax laws and federal legislation affecting different aspects of our lives. What will these new laws mean for our divorcing clients and how should our clients change their legal strategies in anticipation of these new laws?

Tax Issues

First, lawyers can anticipate that their higher-income clients ' those with incomes over $250,000 ' may eventually, not right away, pay higher taxes; perhaps 40% to 44% could be the top tax rate. Individuals earning less than $250,000 will pay fewer taxes. For middle-income families, lower taxes for everyone will mean that the after-tax impact of alimony payments will be less significant and a less important consideration in our negotiations. For high-income families, where the breadwinner is earning in excess of $250,000 and there has been a stay-at-home parent, the possible future increased tax effect is going to be significant.

A property settlement agreement negotiated on 2008 net tax income, fixing alimony based on those figures, could result in a real squeeze if the breadwinner's net income is substantially reduced by rising taxes. Such an arrangement could create a windfall for the parent receiving alimony if her taxes on that money are less.

Thus, starting immediately in anticipation of changes, lawyers representing the chief breadwinner should consider making alimony adjustable from year to year based on the payor's net income. If one is representing the stay-at-home parent, of course, such considerations may not be to his/her advantage, and immediately locking in alimony would be beneficial.

If the parties have substantial dividend or capital gains income, those assets may, in the future, be taxed at a higher rate to repay the government debt created by the bailout. There has been conjecture that capital gains rates will go up to 20% and dividend rates could go up as high as 40%. These considerations are important in valuing options and choosing the overall method of distribution in a case.

It is the usual practice with options to divide them evenly in half and have them distributed net of tax after exercise. This practice should absolutely be the rule in the future. Fluctuating future tax rates will make present offsets “asset swaps” risky.

Given the recession, some options that have been granted may never be above water, especially in the financial and insurance industries. Increased tax rates on capital gains may render options that do have value less valuable. The fluctuations relating to the changes in the capital gains rates can be shared by both parties, if options are divided between the parties net of tax, after exercise.

Regulation May Change the Rules

Government policy will ultimately impact our clients in various ways, depending on the industry in which the breadwinner works. We have already seen that breadwinners in financial and insurance industries have suffered greatly. Management in those industries have stockholdings that have gone down dramatically, in some cases as much as 90%. The policy of the Federal Reserve and the government has everything to do with the survival of our financial institutions and insurance companies such as AIG.

On the other hand, lawyers should be mindful and anticipate the possible negative consequences of future government action under Democratic Congresses for breadwinners who work in the pharmaceutical industry and managed care. It is probable that a Democratic Congress will legislate for government-negotiated prices on Medicare-provided drugs and otherwise squeeze the pharmaceutical industry, as well as regulate managed-care providers to the benefit of the taxpayers, but not those industries' employees and shareholders.

Which Assets Will Be Best?

When one person has had a large proportion of the marital estate distributed to them in the form of one particular asset class or a single stock in a company that has declined in value, it can be anticipated that they will end up with the proverbial short end of the stick. It would be bad representation for lawyers to negotiate disproportionate distribution of stock in companies that they think may have trouble in the future.

Consideration of asset classes within equitable distribution will be important in the future, just as it is as a portfolio management tool. Thus, selling the family residence may be advisable, if retaining the residence would result in one party owning mostly real estate and the other party owning mostly stock and retirement assets. No one really knows which asset classes ' real estate or equities ' will bounce back first and bounce back the hardest.

Bankruptcy Factors

Finally, we can anticipate that the bankruptcy laws may change. The latest proposal for the rescue of the residential mortgage market would permit the government, and possibly even the courts, to change the terms of mortgages and forgive the amount of a mortgage that is over the value of the residence serving as collateral. Homeowners will also be able to reduce interest, or lengthen the term of a mortgage.

Ironically, the bankruptcy laws that were passed recently helped creditors in that they restricted Chapter 7 discharges and forced debtors into Chapter 13 workouts. In a recession it will be interesting to see whether or not the federal government will liberalize the availability of Chapter 7 discharges. Whether or not they liberalize the availability of Chapter 7 discharges, all divorce lawyers in this recession context should be aware of the debtor counseling requirements and services which are available under the new bailout proposals and the bankruptcy laws, as many of our clients will need those services. Joint compliance with a program to retire debt may be a critical component of future property settlement agreements.

Conclusion

Divorce lawyers often feel helpless in the face of clients who have dug themselves into deep financial holes or are innocent victims of the recession. This year will be one of rapid legislative change. It will keep all lawyers on their toes. For instance, tax credits will provide a significant tax benefit for new home purchasers after separation, and it will need to be attributed to the purchaser receiving the benefit.

Lawyers will have to constantly re-examine the advice that they give their clients and adjust their assumptions in addition to helping them to get out of their marriages, as well as out of debt.

Elizabeth L. Bennett is the founder of the family law firm Bennett & Associates in Wayne, PA, and co-founder of the Collaborative Family Law Affiliates. She is a former partner at Dilworth Paxson and a frequent speaker on divorce law-related issues. This article first appeared in The Legal Intelligencer, an Incisive Media sister publication of this newsletter.