When couples divorce, the common assumption is that there will be significant impacts on their finances. They may need to divide retirement accounts. Alternatively, they may need to sell real estate holdings or other assets as part of the divorce agreement.
While the potential negative downsides are well documented, there can be some financial advantages for a couple to divorce. Referred to as a “strategic divorce”, some higher-income couples could see benefits from this prudent approach.
A tactical strategy to avoid the “marriage tax penalty”
The federal tax code does offer some advantages for joint filers. Those benefits start to evaporate as couples move up the income ladder.
The marriage penalty refers to situations where a married couple’s combined income pushes them into a higher tax bracket than if the individuals filed separately. A couple who divorces may be able to earn more separately – and pay a lower rate – than a couple who remains married.
Income taxes aren’t the only tax couples should consider
Income taxes are the primary tax bill that could dictate a strategic divorce, but it’s hardly the only one. The Medicare surtax of 0.9% kicks in at $200,000 for single filers, but it only takes $250,000 for married filers to hit this tax.
Another tax that hits higher-income filers is the net investment income tax. This tax of 3.8% has the same income threshold as the Medicare surtax. Long-term capital gains tax rates are yet another factor that may weigh on filers who are debating whether to utilizing a strategic divorce
The caveat is that state and federal tax laws are constantly in flux and can change dramatically from one election to the next. If you are considering a strategic divorce, you should consult and work closely with a tax professional and/or a financial adviser.