Be Prepared For Tax And Financial Issues That May Arise During Divorce
By Peter Goldstein
The financial and tax issues couples face during and after divorce are often complex. Financial counseling is often necessary to plan for the future, and expert advice may be needed to sort out the marital affairs.
It is common for one spouse to have more knowledge in these areas than the other, especially if he or she is the higher earner or the one who handles the couple’s finances. Often, divorce attorneys, with the assistance of financial and accounting professionals, offer advice to develop an effective plan for identifying and “unwinding” the couple’s investments and business dealings. The goal is to prepare the parties for the new financial realities they will have to face as each embarks on his or her own solo journey post-divorce, with issues such as taxes owed, tax credits and refunds that may be forthcoming, and financial goals and debts that may have to be considered.
Tax and economic issues must be reviewed when determining who will get the house, the business and investment accounts, and the tax consequences of transfers between the parties. Additional issues may arise in regard to eligibility for, or the obligation to pay, maintenance (once known as alimony) and child support. Here are some questions that may come to mind.
What do we own and what is it worth?
The court in a divorce has the authority to divide assets acquired during the marriage. While it cannot divide assets acquired prior to marriage, it can divide the increase in value of the premarital assets that may have appreciated during the marriage.
When a party files an action in court seeking a divorce, both parties become obligated to disclose their assets and debts and what they think they are worth. They may need to hire experts to help determine values of assets as well as exposure for potential tax liability. In some instances, the court may appoint experts to appraise real estate and personal property (moveable items). Tax liability should be considered, even if it is not completely determinable. Parties can still reach agreement as to how such liability will be shared. If you do not know what your tax exposure may be, there are experts who can hired to help determine that and explain it to the court in your divorce proceedings if you cannot.
I wasn’t involved in the financial affairs during our marriage. What kind of problems may arise and what protection is available to me?
You may not know as much as your spouse about the financial affairs during the marriage, but there are procedural rules applicable to every divorce that require parties to share all information and documentation relevant to the couple’s assets and debts so that both husband and wife and the Court can make informed decisions about how assets and debts should be divided. Your attorney can advise you of tools available to obtain “missing” information and records.
Note that with regard to taxes:
When filing income tax returns using “married filing jointly”
status, both spouses are responsible (individually and jointly) for any
tax due as well as any additional taxes, penalties or interest due on
the return. Divorce does not relieve a spouse from owing additional tax
on a joint return that was filed prior to the divorce, but a court can
determine how liability will be allocated between the parties with, for
example, one party assuming all liability, or the parties sharing it equally
or in proportion to their respective incomes. An agreement between the
parties or an Order of the Court may not, however, afford protection should
the IRS come calling. However, some protection may be afforded under the
“Innocent Spouse Rule” which provides relief from responsibility
for a former spouse’s tax bill if it can be shown that the following
conditions are met:
- A joint return was filed;
- There is a substantial understatement (defined as at least $500) of tax due to income deductions, credits or basis of the former spouse; and
- The spouse seeking relief can establish that when the return was signed he or she did not know and had no reason to know that such an understatement existed.
How are the children and child support treated for income tax purposes?
In the course of the divorce, parties can reach a settlement agreement as to who will pay child support and how much, or if no settlement is reached and the matter proceeds to a hearing, the Court will decide the issue. Child support is not treated as income for tax purposes like something a party might earn would be. Accordingly, child support is not subject to income tax. The child support received and the amounts paid have no tax effect. However, child support is a contentious issue. By the time all the other issues surrounding custody, visitation, and other child related matters are addressed, the financial issues can be difficult. It is important to review financial records and prepare a budget for such support. Being well prepared to address these issues can assist in preventing protracted disputes and additional legal and emotional costs in the future.
As part of a settlement agreement or permanent orders issued by the court after a hearing, the divorce decree can include a determination of who gets to claim the children as dependents. This is important because there may be a tax credit or exemption involved and it may be one that can be awarded one party, or shared, say, in alternating years between the two parents. This may be impacted by where the child lives.
The greatest stress of divorce can be fear of the unknown. Consulting with your divorce attorney about what to expect and how to prepare, even before you or your spouse files for divorce, can help reduce fear and uncertainty about what to expect of the process of divorce and what life may look like afterwards. The more you discuss with your counsel about your fears and concerns, be it tax, financial or otherwise, the better you will be able to anticipate what is to come and prepare for it in a calm and rational manner. That is not to say that divorce will be stress-free, but it does not always need to result in high conflict, and preparation can be a key to reducing conflict.