Divorce experts say couples, forced into confinement by the pandemic, are asking about splitting up more than ever. But such divorces, often filled with emotion, have tax consequences.
These splits divide “one balance sheet and one cash flow into two,” said Kathy Costas, a certified divorce financial analyst and vice president at EP Wealth Advisors in Los Angeles. “There are tax implications in both of those equations, but unfortunately many couples don’t seek tax advice. They’re under the misconception that their attorney will give them tax and financial planning advice.”
“The importance of expert financial advice early can’t be overstated,” added Lisa Colletti, a managing director and partner at Aspiriant in New York.
Because of taxes, for instance, “a $100,000 bank account is worth more than a $100,000 stock portfolio that’s appreciated,” said David Weinstock, principal with Mazars Wealth Advisors in New York City. “An appreciated portfolio can’t buy as much as $100,000 of cash, because taxes need to be paid when the stocks are sold.”
“The biggest misconception is that couples can file as married filing jointly for their final [12 months] of marriage,” said April Fleming, a fiduciary tax manager at Tiedemann Advisors in Wilmington, Del., who noted IRS regulations say the couple must be legally married on Dec. 31 of the tax year to file jointly. “The largest impact is that the spouses will now be in the single or head of household filing status, which could have a significant impact on tax liability."
Married filing jointly means both parties will be “individually and jointly responsible for any tax, penalty or interest assessed on the return,” said Jennifer Marshall, senior vice president and director of Tax Services at Bryn Mawr Trust in Hershey, Pa.
If dependents are jointly supported, “it’s best to include this provision in the settlement agreement,” Marshall said. She added that IRS Form 8332 is used for a custodial parent to sign, allowing them to waive their right to claim a dependent in favor of the non-custodial parent. The same form can be used to revoke the waiver.
“Typically, people are concerned with who gets to claim children as dependents, believing it proves who’s a better parent. Other tax issues are much more consequential,” Weinstock said
For instance, the Tax Cuts and Jobs Act (TCJA) made alimony payments no longer deductible or regarded as income on an income tax return. This applies to divorce agreements executed after Dec. 31, 2018. (Alimony might be deductible and taxable after the TCJA sunsets in 2025.) “The result is that there is generally less after-tax income available for both parties to live on,” Costas said.
Depending on the type of retirement plan, a mistake in transferring can cause all or a portion of the assets to be taxed, Marshall said, and could also trigger a 10% tax penalty for early withdrawal.