When a couple faces divorce, the spouses usually end up talking to their real estate brokers, their children’s teachers, their psychologists and their lawyers before it’s all over.
The one professional not on that list who should be is their accountant or tax adviser.
Divorce, besides being an emotional trauma, is a taxable event. And the lawyers who are so good at hand holding, at securing court dates and working out custody disputes may know next to nothing about the finances of dividing property.
Any couple with substantial property who are going through a divorce should call in a financial planner or accountant to consult on the case, if their lawyers do not. A sensible and tax-driven approach to the division of assets can save both partners money in the long run.
Karen Forster is a financial planner recently divorced from another financial planner. The couple were able to put emotions aside, and together wrote a divorce settlement on their own and took it to the lawyers for review.
Forster now works as a consultant to a divorce attorney, using her planning skills to divide property in an equitable manner. She advises anyone going through a divorce to spend some time and money showing the property settlement to a financial expert.
Forster and Bethesda, Md., financial planner David Drucker listed examples of the financial aspects of divorce on which attorneys all too frequently do not concentrate.
* Couples over 55 get a one-time $125,000 exclusion from capital gains taxes on the sale of their residence. If the couple uses that exclusion before they divorce, neither can ever use the exclusion again with a subsequent spouse.
So new marriage partners for either spouse would be prohibited from ever using the exclusion, if they have not already. If they have not lived in the home for at least 3 of the last 5 years, they can lose the exclusion too.
* When one spouse deeds the house over to the other, the recipient also inherits the original basis that the couple has in the house. That means that when one wants to sell the house in the future, he or she will have to pay tax on all of the appreciation on the home’s value, even the appreciation that occurred while the couple were still married.
If, instead, one spouse buys out the other’s share of the house, he or she will have a higher basis for that share when it comes time to calculate capital gains taxes on its sale.
“This can be either an opportunity or a trap,” Drucker said. “It’s best to figure these things out on an after-tax basis to make the benefits more equitable.”
* There are planning opportunities in a divorce: One spouse can transfer his or her Individual Retirement Accounts to the other without subjecting those accounts to taxes. A working spouse can buy a life insurance policy, name the ex-spouse as beneficiary, and deduct the premiums as alimony.
* Pension and Social Security issues are getting progressively more complicated. A non-working spouse who has been married for 10 years is entitled to half the Social Security benefits of the working spouse, as well as a portion of the working spouse’s pension. But the distribution of that plan can have tax consequences and is very difficult to evaluate in current dollar terms.
* Many courts now put values on professional degrees. So if one spouse put the other through medical school or law school, there are ways to calculate what that support was worth, in terms of future potential earnings.
* The decision on how to construct alimony is crucial. Alimony can be deductible to the payer and taxable to the payee, so the person receiving the alimony ought to be clear up front about whether the payer is planning to deduct it.
If the alimony is being paid by an individual in a high tax bracket to one in a low bracket, taxing the alimony can save money for both.
Spouses can forgo alimony in favor of a non-taxable lump-sum payment, but if it is high enough, say $15,000 or more, the Internal Revenue Service can question the non-taxable nature of the payment.
* Child support disguised as alimony or alimony disguised as child support, which is never taxable or deductible, can raise IRS eyebrows as well and is best avoided.
* Spouses can ask for alimony based on a percentage of earnings rather than as a fixed amount, but not, both Drucker and Forster point out, if the payer has control over his or her own income.
* Finally, payments for financial or legal advice on the tax issues that come up in divorce cases are tax deductible, even though other divorce counseling is not.