The Dollars and Sense of Divorce
April 24, 2015
Once a marriage has broken down and a decision is made by one or both parties to divorce, the impact can be devastating; not only to the individuals involved, but also to the children, family, friends and employers of the divorcing couple. Divorce not only has a traumatic emotional impact but a financial impact as well. As an attorney, you are often at the forefront to help clients navigate the impacts such as:
- Negotiating to keep the home when the client can't afford it. Many divorcing spouses want to keep their homes for emotional reasons and to provide stability for the kids. However, maintaining a house also means mortgage, property tax and upkeep expenses.
- Capital gain taxes upon the sale of the marital home or how the sale can impact each party. The rules for the sale of a principal residence were radically liberalized in 1997. Now, if taxpayers meet the "use test" (lived in the house for two of the past five years) and the gain is less than $500,000 for married or $250,000 for single, no income tax is due on the gain. A home with a $500,000 gain would have no tax due on sale if it was sold before the divorce, but if one spouse received the house as part of the property settlement and it was sold after the divorce, that spouse would owe tax on the portion of the gain that exceeded $250,000 (the exclusion amount for single taxpayers).
- Not looking at the long-term impact of a settlement. A 50/50 division of property may seem fair on the face of it, but over time one spouse may be in a much better financial position than the other. This can happen when one spouse earns more than the other (and alimony is not considered) or one spouse receives assets that appreciate over time (rather than depreciate) or one spouse receives assets that have taxes due on them when they are accessed (like retirement accounts) or sold.
- Failing to understand the tax implications of spousal versus child support. Child support payments cannot be deducted by the payor and are not includible in the income of the recipient. Spousal support (also called "alimony") is deductible by the payor and includible in the income of the recipient. The recent trend with spousal support has been away from award of permanent spousal support to awards of "rehabilitative" maintenance for a few years.
- Not taking into account the effect of deferred taxes when dividing the assets. A $100 of cash received in a property settlement is worth more than $100 of a retirement account. Taxes will have to be paid on the $100 in the retirement account when it is distributed and may only be worth $60 after tax.
- Not understanding how to divide debt. When property is divided during the divorce, the spouse that receives the asset is generally also responsible for any loans secured by that asset. Clients may still be responsible for joint credit card accounts even after the divorce is final; prior to the issuance of the final decree, all joint accounts should be paid off and closed.
These situations sometimes require deeper expertise in finances and taxation than many attorneys may have. One way to help clients navigate these issues is by enlisting the services of a Certified Divorce Financial Analyst. CDFAs have the expertise needed to guide clients in this process and avoid negative surprises.
Typically, a CDFA can help clients to understand:
- The difference between personal and marital property
- How property is valued and divided
- Retirement and pension plans
- Spousal and child support
- Tax problems and solutions
- Which settlement to choose
CDFAs can often make the process less complex and provide third-party expertise to help the divorcing parties negotiate with as minimal stress as possible.