by Bob Bordett~When couples are going through a divorce, what are some of the problems that they face while working through the compromise? Probably the two main reasons why couples get divorced are financial and communication issues. There are many factors to consider when preparing for your divorce.
Financially – they look at the different pieces of their collective and individual financial puzzle. They look at the division of assets, tax issues, cash flow and child support. For the division of assets, it is important for the client to understand, first, what state they are living in. Is it a community property state – or is it a fair and equitable division state? Tax issues pertain (pretty much) for federal income tax and must run by the Internal Revenue Service code. Cash flow is exactly what it says. How much cash do I have after I pay federal taxes, state taxes and social security? After I pay all of my taxes, how much cash flow do I actually have in the end? That figure, is what you really have to be able to divide in a divorce!
A lot of times when it comes to the division of assets, we question – is it separate property or is it martial property? That is stated by the state that they live in. For example, if I have an inheritance or gift – is that separate property? It is something that was left solely to me vs. if I work and my spouse does not work. Just because I make all the income is irrelevant. This is marital property it is income earned during the marriage.
A lot of times, people don’t realize that if they get divorced on December 31, or towards the end of the year – they would have been considered divorced for the entire year. It is not pro rata. With knowing that, it takes a lot of tax knowledge to be able to go through and see – are we better to get divorced this year – or since it is so close to the new year, do we wait and look at it for the next year?
The top concerns for clients are the tax issues concerning their division of assets. Probably the two biggest assets that they have to deal with are the house and retirement plans. When they look at the house (especially in today’s economy), a lot of the houses in certain areas of the country pose value issues. They are either at the same value since the time of purchase, or have lost 20-30% of the value; putting them underwater. Being considered underwater means that you owe more on the mortgage than the value of the house. That is pretty predominant here in the southeast as of now. With knowing that, there are a lot of different pieces that we have to look at when couples go through a divorce and they own a home.
Some questions that they have to think about are:
Can one party keep the house
Can they afford the house
What happens if I get the house and then I want to sell it
Big issues to be aware of about taxes primarily alimony. Alimony is taxable to the party receiving it – deductible by the party paying it. You also want to make sure that when you’re structuring alimony that there are certain factors that are met. One rule is alimony recapture (lump sum) or front loading of alimony.
There is another rule called the child contingency rule. That primarily is looking solely for the circumstance when you have a child who reaches age of majority in that state, the child support drops or ceases. You cannot have alimony cease or drop at the same time as child support. An example would be if the IRS notices that little Johnny turns 18 and graduates high school and at the same time the alimony drops. That is against the child contingency laws. You have got to be able to stay away from that pothole.
Another big piece that a client should do before they meet with anybody on a divorce is to gather all of their current statements. This means their 401k statements, bank accounts, savings accounts and investment accounts (any retirement fund statements.) Gather their most current payroll stubs, W2s, the last 2 years of tax returns and then information about their current interest and dividends.
The divorce arena changed within the last 10-15 years. In the past, couples seeking a divorce would simply visit an attorney and just say, “We want to get divorced.” Now it has become a much longer process. Whether they are going to their CPA or their financial planner – you need to really have that expertise so that you’re not getting into that situation to cause a tax problem down the road.