Take Steps to Prevent Divorce From Taking Custody of Your Pocketbook
More than 1 million U.S. marriages are expected to end in divorce this year. If yours is on the rocks, there have been some tax and financial developments in recent years you should know about.
Divorce can be financially devastating for both parties, because of legal fees, the cost of dividing assets and ongoing support arrangements, such as child support or alimony.
Divorcing spouses who aren’t careful also can end up with inadequate settlements, ruined credit and tax problems, said Ginita Wall, a San Diego financial planner and certified public accountant who last week taught a “Divorce and Taxes” seminar at a personal finance convention for CPAs.
Here are some things she says divorcing couples should keep in mind:
The house. Homes became a more valuable asset in 1997, when Congress changed the tax law to allow each person to exempt from taxation the first $250,000 of profit from a home sale. That means couples could potentially get a $500,000 tax-free windfall on the sale of a home, often making the house more valuable than a taxable asset of equal size, such as a retirement account, Wall said. (Retirement accounts typically offer tax-deferred growth, but participants must pay income taxes on any withdrawals.)
To take advantage of the home sale profit exclusion, the seller generally has to have lived in the house for at least two of the last five years. That would seem to limit options for divorcing couples, who often want to delay selling the home until, say, the children graduate from high school several years down the road, Wall said.
Fortunately, there is an exception in the tax law just for couples on the outs. If one spouse is granted exclusive use of the home as part of a written separation agreement or divorce order, the other spouse is treated as if he or she were still living there for home sale tax purposes. One spouse can move out, the sale can be delayed for several years and both (now former) spouses can sell for a tax-free profit of up to $500,000.
The debts. Divorce lawyers and credit counselors can tell many tales of vengeful or simply irresponsible ex-spouses ruining their former partner’s credit. Although most divorce agreements divide up the debts, creditors can legally go after either person for most debts incurred during marriage--regardless of what the divorce order says.
There are smarter approaches than simply taking an ex’s word that a debt will be paid, Wall said. These include selling jointly owned property to pay the debt as part of the settlement, or separating the debts in ways that don’t leave creditors the option of pestering the other spouse or trashing his or her credit.
The proliferation of credit card offers in recent years--particularly those with low-rate balance transfer options--often makes dividing debt easier, Wall said.
Divorcing spouses can apply for credit cards in their own name, using only their own income to qualify, and then transfer balances from jointly owned cards or accounts to those new cards. The joint accounts should then be closed to shut off the possibility of an ex running up any more debt under both names, Wall said. A joint debt transferred to a card that’s in one spouse’s name becomes the sole liability of that spouse, she said.
The credits. Children, too, are now worth more in a divorce, Wall said. Several valuable tax credits are available for middle-income families with children. Who gets what credit should be part of any divorce agreement.
Most of the tax credits go to the parent who takes the tax exemption for the children. (The exemption is the $2,800-per-person write-off that’s available for each taxpayer and dependent.) The custodial parent typically is the one who gets to take the exemption. But the custodial parent can give the exemption to the other parent by signing a Form 8332. Thus, an exemption can be an important negotiating point in a divorce, Wall says.
(This option doesn’t apply to the dependent-care tax credit, offered to parents who work and pay for child care. A parent must have physical custody of the child to take this credit.)
Parents with the exemption can take a full $500-per-child tax credit if the child is under 17 and the parent’s income is under certain limits. The credit is reduced by $50 for each $1,000 of the parent’s income exceeding $75,000 if filing single or head of household, or $110,000 for joint filers.
Other potentially valuable credits are the Hope and Lifetime Learning Credits. The credits begin to phase out when incomes reach $40,000 for single filers or $80,000 for joint filers. The parent must both pay the education expense and take the exemption for the child to take the credit.
If one parent can qualify to take the credit and the other can’t because his or her income is too high, a little cooperation can produce a better financial result for both, Wall said. The higher-earning parent could funnel money for college tuition to the lower-earning parent, for example, who could agree to pay for more of the child’s books in return for the ability to take the credit.
Wall said she has found that many couples are willing to work out such agreements, even if they’re fighting about other issues.
“What most people can agree on is that they’ve got great kids and they don’t want to hurt the kids in the divorce,” Wall said.
Stock options. Retirement plans are routinely divided in divorce, and transfers from one spouse’s plan to the other spouse’s individual retirement account aren’t taxable if made according to a qualified domestic-relations order (known as a “quadro”).
But the IRS has yet to make it clear whether, and how, divorce-related transfers of employee stock options can be taxed, Wall said. Since stock options can be a large part of some couples’ wealth, the issue can be perplexing for divorcing couples and their advisors.
Not all companies even allow employees to transfer their options to someone else, Wall noted. If transfers aren’t allowed, the divorcing couple is faced with the task of guessing how much the options might be worth when exercised and perhaps dividing up other assets differently to account for the stock options’ potential value.
Innocent spouse. Anyone who signs a joint return is normally responsible for paying the tax and any extra taxes, penalties or interest that might later result, such as during an audit.
Congress created two exceptions. Spouses who didn’t know that the other was hiding income or misstating the facts can apply for relief under so-called “innocent spouse” rules.
Separated or divorcing spouses may also opt for “separate liability,” which can limit their responsibility for taxes that arise from a joint return. RIA, a tax research firm, recommends opting for separate liability whenever a divorcing spouse believes the other has falsified entries on a tax return or if the other spouse has few assets.
The rules for innocent spouse and separate liability are complex, and the IRS has been flooded with applications for both since Congress changed the rules in 1997. The IRS offers some information for taxpayers in Publication 971, which is available at IRS offices and at its Web site, https://www.irs.gov. But divorcing spouses who fear they may have a tax problem should consult professional tax preparers who have experience in innocent-spouse applications.
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D-I-V-O-R-C-E
About 1 million U.S. marriages are expected to end in divorce this year. Here are some other divorce statistics:
Divorce rate per 1,000 Americans (1999): 4.1
Lowest divorce rate: Massachusetts, 2.4 per 1,000
Highest divorce rate: Nevada, 9.0 per 1,000
Median marriage longevity: 7.2 years
Chances new marriage will end in divorce: 43%
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Note: Data for 1990, unless noted.
Where to go for help
“Divorce and Money: How to Make the Best Financial Decisions During Divorce” by Violet Woodhouse and Victoria F. Collins (Nolo Press, 2000).
Several Web sites specialize in information on divorce. They include www.divorcesource.com, www.split-up.com and www.divorcemag.com.
The California Bar Assn. at www.calbar.org can provide a list of family-law specialists.
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Sources: National Center for Health Statistics, Times research *
Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.
