When it comes to divorce, taxes can generate headaches for both spouses. Yet tax issues also present a unique opportunity for creative settlement solutions to help couples avoid unbalanced final agreements. Some solutions even make it possible to circumvent litigation altogether.

Unfortunately, for a variety of reasons, family law attorneys are not always as authoritative as they should be on the tax law details that pertain to divorce.

Because of the many complex issues in divorces, attorneys and courts focus more on non-financial issues, such as contentious custody battles. A substantial number of attorneys also simply never bother to fully read the statutes about taxes, so they have only a vague familiarity with the topic instead of a complete understanding of details.

Financial advisors can catch these oversights and thus be extremely beneficial to both parties throughout the divorce process: Someone who fully understands the subtleties and nuances of taxes and financial planning is invaluable for producing innovative settlements addressing a number of common issues:

  1. Alimony -- The recipient must recognize this money as income, and the payor is able to take a tax deduction. One tax advantage for claiming maintenance is that it counts as an above-the-line deduction.
  2. Child support -- Just as money spent on children when you are married is not tax deductible, neither is child support. There can be no deduction when a parent writes a check for child support or when the parent with custody spends money on a child.
  3. Dependent exemptions -- The general rule is that the parent with primary custody claims the dependency exemption because he or she is paying most of the support, although judges have the authority to order otherwise. Both parties can also agree to a different arrangement; however, that requires the child support recipient spouse to sign IRS Form 8332 each year, designating that the other parent will claim the deduction.
  4. Property division -- The division of property is not considered a taxable event. Each party receives his or her share of assets with the original basis, and if an asset is split, the basis is split as well.
  5. Home sale exclusion -- As long as their divorce has not been finalized by December 31, a couple is still considered legally married. This means they can still file a joint return, which allows them to receive the entire $500,000 of tax-free gain on their home. If their house is sold after the divorce, each party is only able to claim the individual exclusion of up to $250,000 each.
  6. Deferred compensation retirement assets -- “Qualified domestic relations orders” were developed to ensure taxation is not automatically triggered when couples divide retirement plans; however, the recipients are subject to the same limitations as the original plan holders.

Knowing the tax rules can allow you to achieve more subtle gains in settlements. You can often surmount roadblocks in settlement negotiations with imaginative and beneficial solutions using the subtleties of tax law. It may be that one party can walk away with a post-tax sum that was equal to the other party’s, even though it appears the former received nominally more in the pretax settlement.

A financial advisor’s ability to see past the initial distribution value of a post-tax agreement can also help change the way clients view certain assets. Something that frequently arises during divorce is the valuation of liquid assets, which are compared with equivalent non-liquid assets.

For example, say a couple has $100,000 in a savings account, as well as $100,000 invested in a 401(k). While both accounts technically hold the same monetary value at the time of division, it can make an entire world of difference whether you have access to the money now or later. It is entirely possible for a financial advisor to craft a persuasive argument calling for a discount on the valuation of the 401(k) since it lacks liquidity. Or the advisor could argue the opposite—that you cannot make the savings account tax-proof for the next 40 or more years.

Taxes offer couples and their lawyers an opportunity to make subtle arguments to the courts about the true value of their assets, whether the liquidity is an advantage or not, and to argue about the implications of taxable assets. It is an opportunity for sophisticated debate, which is often where attorneys need the advice of advisors.

The advisors can bring to the table a proficiency that attorneys lack, which could ultimately allow a divorce to settle instead of go to trial. The tax subtleties allow attorneys to adjust allocations by taking into account specific taxes, to negotiate for those assets burdened by taxes and those that aren’t, to cover liquidity issues and to clarify tax liabilities.

Advisors could lend their expertise as consultants during the settlement negotiations, as expert witnesses during litigation or as behind-the-scenes advisors helping prepare one party for trial. All of these functions allow them to identify relevant tax issues and design creative solutions that attorneys all too often overlook.

First « 1 2 » Next