Divorce is difficult. Dividing assets and wealth throughout the process is often complicated and fraught with emotion. However, from a tax and financial perspective, planning opportunities exist when both parties are invested in everyone’s best interest. When we are dealing with situations of divorce, we use our expertise to make sure our clients understand that different assets have different tax liabilities, and we make sure they understand how certain assets of theirs will be taxed. In situations where there are significant assets, deciding who should get what can be a challenge, even in the most agreeable situations.
Pre and Post Tax Savings Accounts
Assets need to be viewed well beyond the dollar amount, and viewed as to what is best for both parties, short and long term. There is a big difference between splitting up a 401(k) or IRA vs. after-tax savings accounts (i.e. brokerage accounts). Also, the assets within brokerage accounts need to be looked at well beyond the dollar amount. Depending on the stock, it may or may not incur capital gains tax, which would have a large effect on the post-tax dollar amount received.
Many people automatically assume that sharing dependent exemptions 50/50 on tax returns is fair and equal for both parties. However, depending on the circumstance this does not always make sense (i.e. one spouse is a higher income earner and subject to the Alternative Minimum Tax “AMT”). In the same vein, there may often be reasons why child and education credits should not be taken advantage of. This is very specific to an individuals’ circumstances, and would have to be discussed in greater detail with your professional advisor.
Fair is not always equal
As stated above, planning opportunities exist when both parties are invested in everyone’s best interest. Examples of this include items such as alimony, which is taxed to the recipient, and child support, which is not taxable to the recipient. When both parties are amenable to each other’s planning opportunities, advantages for both parties exist. An example of this is a high income earner paying alimony to someone who stayed home to raise the children.
As you can imagine, divorce has become more complex over the years with changing societal norms, such as more women entering the workforce. Also, according to the New York Times, if you are living in the United States you are subject to a nation with the “highest divorce rate” in the Western World. The tax law has also become more complex, and will most likely continue to change, especially with the current House Tax Bill. The Bill proposes to eliminate the alimony deduction as well as no longer require alimony received to be taxable. However, the recent Senate Bill is proposing to keep alimony as it currently stands. Other areas within the House Tax Bill that may affect divorce planning are education credits and dependency exemptions.
Note: that until a divorce is official, the tax return filing status of married filing joint can still be submitted to the IRS.