Tag Archives: PEP

The fiscal cliff deal and its impact on child support and spousal support

The amount of taxes an individual pays is one of the significant factors impacting the amount of support paid.   As a result of the fiscal cliff deal, aka the “American Taxpayer Relief Act of 2012” (“The Act”),  a high earner who pays support under an existing support obligation may be paying too much in support if the support order was made before December 31, 2012.

In general, higher taxes will reduce a payor’s support obligation, but tax deductions including breaks tax payers receive for mortgage interest, property tax and charitable contributions increase a payor’s support obligation.   The concept here is that if a person receives some tax break, he or she has more net spendable income (i.e. less money goes to taxes and more money is in her or his pocket) to pay support.

Under The Act, higher earners will be in higher tax brackets, plus they may lose some value in their itemized deductions as a result of the re-emergence of the “Pease Limitation,” which is a limitation on itemized deductions.  Pease was phased out years ago — but now is back in play with The Act.  This limit kicks in and begins limiting itemized deductions once an individual’s gross income hits the “applicable amount.”   The “applicable amount” for single filers is $250,000 and for joint filers it is $300,000.  All income over the “applicable amount” reduces your tax deduction by 3%.  For example if you file as an individual and declare an adjusted gross income of $500,000, then you are $250,000 over your “applicable amount” which means you lose 3% of $250,000 – or $7,500 of your total itemized deductions.  In other words, that $7,500 is no longer sheltered from taxes and if your support order was created prior to December 31, 2012, the calculation used most likely is incorrect – i.e. the calculation incorrectly assumes that the $7,500 is sheltered from taxes – and hence the support order is too high.

There’s more.  In addition to the Pease Limitation, The Act restores prior Personal Exemption Phase-Outs (“PEP”).  Under PEP, individuals with adjusted gross incomes over the “applicable amount” can no longer claim their full personal exemption.  For 2012, the personal exemption was $3,800.  Under The Act, for every $2,500 an individual’s income surpasses the “applicable amount”, then the individual’s exemption is reduced by 2%.  For higher earning individuals who pay support, this phase out means greater taxes which mean a pre-existing support order is probably too high.

Of course, the Pease limitation and PEP phase-out apply to all tax payers, including not only parties paying support, but parties receiving support.  The tax effects of the Act on BOTH parties must be reviewed to determine the correct level of support.