Having consulted on a number of divorces in the last couple of years, I wanted to provide a broad overview of the tax implications which, understandably, are the last thing on anyone’s mind during such a time. A little effort on the front end can avoid wasted tax dollars and arguing over tax benefits that ultimately may not matter, as well as addressing issues that could save both parties $$ down the road. I hope you’ll find this a helpful, approachable start from a tax perspective if you or someone you know is contemplating a split.
You need a team
An excellent family law/divorce attorney is a no-brainer. Also consider working with a QDRO attorney if separating retirement plan assets isn’t your divorce attorney’s strong suit. An estate planning attorney is a must. Most folks think of sitting down with an estate planner after the divorce is finalized, but a discussion before hand could be helpful if there’s concern over estate planning issues during the divorce (which could be lengthy).
Your financial planner makes a great quarterback for the money & estate planning side of things. If business assets are involved, a valuation expert will be needed.
A good tax advisor will play well with this group by providing consulting around general divorce-related tax issues, explaining how specific ones will apply to your particular situation, and be available to answer tax-related questions that could/should factor into negotiations.
If tax implications are considered without the assistance of a professional, among the obvious concerns are:
• Who will/should claim the kids as dependents and receive dependent-related tax benefits.
• How itemized deductions should be split, e.g., joint charitable contributions, home related deductions such as mortgage interest.
• Potentially taxable alimony vs non-taxable child support.
Here’s some of what I see that is generally not considered without a professional’s guidance:
• Splitting estimated tax payments and prior-year overpayments.
• Alimony recapture
• How to address potential prior-year tax obligations that may pop up down the road.
• Deciding whether to file jointly or separately leading up to the divorce. Often, the married-filing-separately option isn’t considered even though one or both parties may not want to put their name on the other’s tax return.
And the biggie
Often, assets transferred in connection with a divorce don’t have an immediate tax effect for either party. As such, once state law, emotional ties, and business needs have been addressed, asset division can seem primarily a function of the assets’ fair market values. However, holding and/or selling assets usually has tax implications that should be considered before signing on the solid line.
For example, you get half the Coke stock, he gets half the Coke stock. Seems fair until you go to sell and realize he got the half that was recently purchased (high cost basis) and you got the half that was decades-old (low cost basis), meaning your taxable gain is higher than if you had factored in cost basis into the split. Ugh.
In situations with significant and/or multiple types of assets – businesses, real estate, financial assets, etc., – an analysis of how the parties stand from a tax perspective can minimize the chance of unexpected, unfavorable tax consequences later on.