In Divorce, 50-50 Split May Not Be Equal
Darylle Goodfield got a firsthand demonstration of why it’s smart to seek financial advice, as well as legal counsel, when getting a divorce.
A month before she was ready to enter a final settlement with her estranged husband, a financial planner glanced at her paperwork. According to the planner’s analysis, the couple’s 50-50 asset split wasn’t as equal as it appeared.
Most of the assets Goodfield was getting were taxable, while the assets going to her husband were not. Because of this, the planner said, Goodfield would be getting $30,000 less on an after-tax basis.
That’s not uncommon, said Ginita Wall, a San Diego certified financial planner who specializes in the financial aspects of divorce.
“Any time people are trying to trade assets, this type of problem arises,” she said. “That’s because the biggest assets most families have are the house and the retirement plan. But the house can be sold without paying tax, while the retirement plan cannot.”
State laws spell out formulas for dividing marital assets and figuring child and spousal support. However, the laws give couples a great deal of leeway when structuring the details--such as who gets which bank accounts and whether one spouse will take the brokerage accounts while the other gets the Porsche.
This latitude gives individuals the ability to keep the items they hold most precious, but it also can result in unintended disparities.
What should you know about the financial aspects of divorce, if you’re among the more than 1.1 million people calling marriage quits this year?
* Dividing assets: In California and other community property states, communal assets are divided equally, regardless of who earned the most money or spent the most during the marriage. That’s based on the idea that a judge shouldn’t be involved in personal decisions, said Violet Woodhouse, a family law attorney in Irvine and author of “Divorce & Money: How to Make the Best Financial Decisions During Divorce.”
Non-community-property states have equitable-distribution systems, which provide more judicial latitude in asset splits. But Woodhouse said more states also are concluding that the value of assets and liabilities accumulated during a marriage ought to be split essentially in half.
* Splitting debt: Divorce courts generally split debts the same way they do assets, but lenders and the Internal Revenue Service often hold both parties liable. Translation: If one spouse doesn’t pay his or her share of the debts, the other spouse could be forced to pay--no matter what the divorce decree says. It’s wise to pay off joint debts in the process of splitting other assets and close any joint accounts so these obligations won’t come back to haunt either party, Woodhouse said.
The one exception: Mortgage debt generally can be assigned to the party who takes the house. But even here, it’s wise to be cautious if one spouse has a history of being irresponsible with money.
* Not divisible: Some assets are not communally owned and generally are not divided in divorce. For instance, inheritances are separate property, as is property that was accumulated before the marriage.
Though both parties must disclose the value of their separate assets, they don’t have to share unless the couple commingled this property during the marriage, Woodhouse said. In such cases, the court may split these assets if it’s unclear that they were truly separate property.
* Tax adjusting: Different types of property have different tax characteristics when split up, Wall noted.
For instance, withdrawals from a tax-deductible retirement plan are taxed at ordinary income tax rates. That can reduce the net value of these assets by one-third or more. But taxpayers get a $250,000-per-person exclusion from the tax on profit from the sale of a personal residence. That can make proceeds from the sale of a home tax-free.
Stocks and bonds held in taxable bank and brokerage accounts could generate either taxable gains or deductible losses, depending on when the assets were purchased and at what cost.
There are two ways to make property splits fair both before and after tax, Woodhouse said. One is to divide assets into types--for instance, retirement accounts, taxable accounts, personal property (furniture, televisions, cars) and real estate--and then split the property in half in each category. Each spouse’s settlement would be a mirror image of the other’s.
This approach won’t work if one spouse wants to keep the house or a retirement plan, Wall noted. Then it’s wise to get a financial planner to tax-adjust the property settlement. If one partner takes more nontaxable assets, the other should get taxable assets with a greater dollar value to compensate, she said.
* Child support: If there are children from the marriage, the higher-earning parent may be required to pay child support. Child support formulas are the most rigid part of a divorce proceeding, Woodhouse said. However, there are exceptions when the formula creates a hardship for either the paying parent or for the children.
Most states post their child support formulas on the Internet, although finding the specific code may require a fair amount of searching. A good place to start such a search is at https://www.supportguidelines.com. Also, https://www.divorcesource.com links to family law statutes in each state and even provides referrals to family law attorneys and counselors.
Federal tax deductions for dependents generally are given to the custodial spouse. But that can be reversed if the other spouse is providing more than half of the children’s support. Often, the question of who gets the dependency deductions can be included in the divorce decree.
Child support is not tax deductible for the giver or taxable for the recipient.
* Alimony: Courts increasingly expect both spouses to work and support themselves. Awards for temporary support are far more common than for permanent support. Indeed, alimony is an issue in only about one in six divorces. Alimony payments are deductible for the giver and taxable for the recipient.
Kathy M. Kristof can be reached at email@example.com.