The tragic deaths of Anthony Bourdain and Kate Spade shed light on how unconventional some marital and family situations have become in the new millennium. Both had been separated for a lengthy time, but never legally divorced. Gwyneth Paltrow and hubby Chris Martin decided to “consciously uncouple” and co-parent their children before later divorcing. This is another diverging pattern in marriage, cohabitation, and parenting.
Changes in lifestyle and family structure almost always come with tax and financial implications – some positive and some negative. Alimony, estates and trusts, retirement plans, co-mingled funds, insurance and many other spousal/parental financial issues need to be carefully considered. Due to tax reform, assumptions should not be made regarding tax deductions, child support, joint returns, etc., as these can all present problems. Tom Cruise is probably happy his 3 divorces are in the past. Most of us are mere mortals, not movie stars, so it is even more important to deal with the financial impact of separation and divorce, know your obligations, and how to protect yourself and your family.
Keep in mind that even though you are separated but not divorced, you are still considered married for tax and legal purposes.
Tax benefits abound for married couples, which would include couples separated but not legally divorced. One such benefit is that spouses can transfer appreciated property between themselves tax-free, no gain or loss is recognized, and flip property back and forth without tax liability.
But when filing a joint return keep in mind that the liability is shared. If there’s a problem or deficiency the IRS can come after either the husband or wife, or both. You may realize too late that your significant other did not report all of his or her income.
Your marital status at the end of the year determines what your status is when you are filing. If by December 31st, your divorce is final, you will be able to file separately as an unmarried individual. If you have children, you may be able to file as “Head of Household” under certain conditions. Consult with your Fuoco Group tax professional to decide the best filing status for your situation. After you have gone through a divorce, you may want to consider changing your W-4 to make sure that the amount your employer is withholding will be accurate.
Even if spouses are separated, they may still have inheritance rights depending on state law. Take a hard look at who is listed as a beneficiary of retirement accounts, trusts, life insurance policies, etc., and be sure to consider issues that might arise if either spouse stands to inherit assets from the death of their parent.
When tax planning for the upcoming year be sure to consider that one provision in the Tax Cuts and Jobs Act which makes it worthwhile for those who want to get divorced to do so by the end of 2018: the elimination of the deduction for alimony. Alimony will no longer be deductible by the payor, and the income received by the spouse will not be taxed. This may mean less dollars are available to split between the divorcing spouses. If truly considering divorce, look at whether it makes sense to divorce before the end of 2018 to take advantage of the alimony deduction for the larger wage earner. If your divorce case is close to settling, you should hope to close it out before the end of 2018. The IRS has yet to issue guidance on prenuptial agreements with provisions affected by tax reform. There might be the need for post nuptial agreements to address changes in the tax law that affect alimony.
Child support payments are not tax deductible to the payer and are not taxable income to the payee. Do not assume that because you are paying child support you can automatically claim that child as a dependent on your tax return. Unless you have an agreement otherwise, the custodial parent claims the child as a dependent on their tax returns.
The new tax law also eliminated the personal exemption so for tax years 2018-2025 so the dependent deduction is no longer available. However the child tax credits are still available and actually more generous than in prior years. If you are able and eligible consider using some of your child support payments to fund a 529 savings account for their education.
Business valuations may be impacted by tax reform and have an effect on divorce negotiations. Cash flows will increase for pass-through entities and businesses may be valued at higher amounts. A forensic accountant can be of assistance here. Assets should be unencumbered: no liens, or hidden capital gains taxes due.
More is not necessarily MORE. When looking at brokerage accounts be sure to see what liabilities there are. If the brokerage account has capital gains, then a home with no mortgage may be the better asset.
A separated spouse generally has no rights over the retirement plan of their husband or wife, and may not have a clue as to what the other spouse is doing with assets. When you file for divorce however, a restraining order automatically prohibits the separated spouse from moving money around.
Defined-benefit plans are usually not portable or accessible prior to retirement. They can be valued and paid as a lump sum, or a Qualified Domestic Relations Order (QDRO) is created so the nonparticipating spouse gets a share of the benefits later, and spouses are allowed to roll over the payments from the plan tax-free.
Alimony recipients will now have less ability to make IRA contributions. Taxable alimony income qualifies as a contribution because it’s treated as compensation, but tax-free alimony will not qualify.
A spouse entertaining divorce needs to choose assets wisely to secure their financial future by providing an income stream to sustain their lifestyle. In financially-complex divorces, the process can take months, or even years. At the end, you may know exactly what must be divided and how, but will still need to work through the practical details of how to implement the final agreement. Remember that just like assets, liabilities may also need to be divided in divorce.
Need help building a financial foundation? If you haven’t already done so with an attorney, you will need to:
2. Cancel any joint credit cards and establish credit in your name alone.
3. Avoid leaving a marriage with high debt.
4. Disinherit your spouse. You probably don’t want your ex to inherit from you if you die. Change your will and other estate planning documents accordingly.
5. Update insurance policies, retirement accounts, pensions, trusts, annuities, and change the beneficiary designations.
6. Split retirement plans like 401(k)s or other pension plans with a QDRO.
7. Consider the change to the tax benefits of owning a home. You now have a reduction in the deductibility of property taxes and the amount of mortgage that qualifies for interest deduction. When you sell you can realize up to $500,000 in gain without tax consequences if married, but only $250,000 of gain with no tax due if you sell when single. Analyze whether it is best to sell the marital home before your divorce is final.
8. If you want to keep the marital home, look into refinancing the mortgage in your name alone.
9. Arrange automatic transfers from your spouse’s bank account for alimony or child support payments.
10. If the reason you haven’t yet divorced is health insurance, you are not alone! Should you lose your health insurance, see if COBRA is available.
11. Make a budget and stick to it. Consider financial planning to ensure that your settlement lasts as long as absolutely possible.
12. Make your Fuoco Group CPA and financial advisor a trusted part of your team both pre- and post-divorce.
Contact Us: If truly considering divorce, don’t forget another big part of the settlement process is taxes! You must consider the tax implications of any settlement decisions made. Attorneys may focus on the best settlement possible but may lack experience or expertise regarding the tax impact, especially when assets need to be divided or sold. To discuss your situation, contact Lou Fuoco, CPA, at 561-209-1101. Having a CPA on your team with experience in divorce matters may provide a fairer and more equitable distribution of marital assets and position you on firmer financial footing.
***This article not intended as legal or financial advice.
