Four Mistakes That Could Cost You Thousands of Dollars in Your Divorce...And How to Avoid Them

We see a lot of divorce decrees in our office. When I say a lot, I mean, a lot. Invariably, we see a lot of financial mistakes in those decrees too.  While every state is different, federal law reigns supreme. If this is your first tax season post-divorce, or if you are in the middle of your divorce proceedings, paying attention to these four most common mistakes will pay huge dividends later on.

Don’t forget IRS form 8332

IRS form 8332 (release/revocation of the release of claim to exemption for child by custodial parent) is a crucial form if you have dependent children eligible for child tax credits. If the non-custodial parent is going to claim the above-mentioned tax credits, the custodial parent, pursuant to your decree, must sign and release IRS form 8332 to the non-custodial parent.  The non-custodial parent retains this form as proof they can claim the tax credits. For most couples, this form is signed every year. You can find it here: https://www.irs.gov/pub/irs-pdf/f8332.pdf

Don’t forget the Other Dependent Credit

The Tax Cuts & Jobs Act, which started in late 2017, but mainly applicable in 2018, has substantially changed the tax landscape. This is particularly true for divorcees and soon-to-be divorcees. Because of the broad changes to the tax code, many divorce decrees are incongruity to these new laws. The Other Dependent Credit is a $500 non-refundable tax credit for dependents older than 17 that do not qualify for the child tax credit. Generally, we see two situations:

1. Divorce decrees enforced prior to the law change generally do not address the Other Dependent Credit. Sometimes the language in the decree is written too specific to accommodate the old laws and states that the exchange of tax credits end when the youngest child turns 17. If this is your situation, you and your former spouse will need to either work together or modify your decree in accordance with the new laws.

2. Too many attorneys do not understand or are unaware of the new tax law. We are still seeing new decrees where the language does not jive with the new tax laws.  Having a federally licensed Enrolled Agent or CDFA® on your divorce team, or as a financial neutral, can help you avoid these mistakes.

Don’t Forget Who Get’s to Claim the Child & Dependent Care Credit

If you are a working professional & have young children, it’s quite possible those children are in some form of daycare. As you may know, daycare can be extremely expensive! The IRS provides a tax credit where you can get 20% to 35% of up to $3,000 of child care & similar costs for a child under 13, an incapacitated spouse or parent, or another dependent so that you can work (and up to $6,000 for two or more dependents).

What happens in a divorce when both parents are sharing this cost? Can both parents claim this credit? Can it be rotated every other year?

The IRS is very specific that a qualifying person may only be claimed on one tax return. If a dependent is claimed on more than one tax return (for example, a child is claimed by both divorced parents) the IRS will apply a set of tiebreaker rules to see who gets to claim the dependent.

Alimony: Is it taxable?

Pursuant to the Tax Cuts & Jobs Act of 2017, alimony is no longer considered taxable income for any decree signed in force after midnight, December 31, 2018. If your divorce was finalized prior to this date, then you are subjected to the old laws & will continue to report alimony as usual.

But what happens if you are under temporary orders, receiving payments but in a lengthy divorce proceeding that hasn’t finished but started prior to the cut-off date mentioned above? What happens if you or your former spouse takes you back to court with the intent to modify your alimony payments?

The answer here is not so clear cut.  To help in these more complex situations, the IRS clarified the definition of a divorce instrument to include:

• A decree of divorce or separate maintenance or a written instrument incident to such a decree.

• A written separation agreement.

• A decree (not described in clause (i)) requiring a spouse to make payments for the support or maintenance of the other spouse.

Additionally, if you read the actual bill, there is a section that clarifies how divorcing couples can deal with these situations:

“any divorce or separation instrument (as so defined) executed on or before such date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification.” Source https://www.congress.gov/115/bills/hr1/BILLS-115hr1enr.pdf

From a tax perspective, as we read the bill, we interpret this to mean that should a final decree signed prior to the law change be modified after December 31, 2018, the parties can choose whether or not be subjected to the old law or the new law. What’s the bottom line? Consult your attorney & a tax advisor if you’re in this situation.

Getting Divorced? Don't make these tax-mistakes.

Paying attention to your taxes while getting divorced can be a lot like walking a tightrope! It’s really easy to lose your balance. Having a safety net of professionals in addition to your attorney can prevent you from making fatal financial mistakes.

We see a lot of financials, stipulations & divorce decrees in our office. Most are well-drafted and cover all the bases. Every once in a while, we will have a tax or divorce client come in with a settlement agreement which created negative and unforeseen consequences.  As all assets are not created equally, it's important to watch out for these and other issues before signing your decree.

• IRS code 1041 allows for a non-taxable transfer of assets between spouses during a divorce. Sometimes our client’s assets include things like business interest, real estate or other assets that are titled and owned by another legal entity. While 1041 rules protect individuals, the case is not always the same for entities. Paying attention to titles & ownership will prevent unforeseen tax issues for you.

• Employer sponsored retirement accounts such as 401k, 403b & 457 plans are split via a Qualified Domestic Relations Order, or QDRO. The IRS allows for penalty-free distributions from these plans for the non-employee spouse, which is referred to as the alternate-payee.  It’s important to remember that while these distributions are not penalized, they are still considered taxable income. Additionally, the 10% penalty waiver does not apply to IRA accounts.  Once those assets are transferred to the IRA in the new owner’s name, they are still subject to the normal distribution rules.

• In high net worth cases it’s common for us to see capital loss carry-forwards from either stock or real estate.  Capital losses occur when stock is sold, with a maximum loss of $3,000 per year. Any remaining amount is carried forward to the next tax year.  Additionally, net operating losses (NOLS) from business or investment real estate follow somewhat similar but complex rules. NOLs can be carried back up to 2 years and carried forward indefinitely. For non-professional rental real estate, the losses start to phase out after $100k income and are capped at $150k. Anything partially or completely phased out carries forward. The IRS does not allow for a split or transfer of capital losses from one taxpayer to another. What this means is that the valuation and taxation of the asset could be overlooked. Therefore, attention to the ownership & title of the asset as mentioned above is extremely important.

• Pay attention to your filing status, especially if your divorce is finalized late in the tax year. If you are the breadwinner and paying child support, more than likely your filing status will change from Married filing joint (MFJ) to Single. If this is the case, you must consider changing your tax withholding as you’ll be in for a nasty surprise come tax season.

• Creative divorce settlements can help you maximize your income. As of midnight December 31, 2018, spousal support payments are no longer considered taxable income for any new divorce decrees. Any decrees signed prior to this date, including modifications, are grandfathered into the new tax law. Recently we had a client who’s soon-to-be-ex wanted to stay in the marital home.  After consulting with us & his attorney our client agreed to a settlement where part of his spousal support was represented through the mortgage payments. Why was this important? Since he is still able to itemize, the mortgage payments and property taxes are still deductible on his schedule A. Had he just paid the support directly to her, he would have lost this favorable tax break.

 As a Certified Divorce Financial Analyst, CDFA®, and Enrolled Agent, EA, I have a unique skill set that could mean a more equitable and financially independent transition for your divorce. You can contact us at info@fitdivorce.com.

What is Divorce Financial Mediation?

Like other mediations, a financial mediator services as a neutral facilitator rather than as an advocate & advisor representing one party in the divorce. The facilitator provides a structured process to guide the clients toward mutually agreeable decisions.

Participating in mediation for financial matters in divorce can be a constructive, non-contentious means of coming to agreement on financial issues in your divorce process.

Alternative dispute resolution methods such as mediation are more likely to result workable decisions that are more likely to be kept and more likely to support a doable relationship going forward.

 A financial mediator brings financial knowledge, insight, and understanding to the table to guide clients through current challenges and helps to foresee potential issues in the future.

 A Certified Divorce Financial Analyst brings specialized knowledge to works with clients. Services include:

• Characterizing and evaluating assets

• Developing budgets and projections to address financial needs post-divorce

• Looking at long term implications of settlement decisions

• Determining after-tax values & basis of property

Financial mediation begins with a discussion to identify needs, wants, wishes and concerns as they relate to:

• The mediation process

• The children

• Property

• Taxes

• Anything else that applies

From this point the clients and mediator identify the items requiring decisions and decide on actions to move forward.  The decision oriented discussions that follow focus on information from the identified interests and agreed upon information to identify possible options and solutions.

Typical challenges that may be addressed in financial mediation

• What to do with the house

• Support needs analysis

• Dividing children’s expenses including college

• Dividing assets across asset classes including

  • Retirement funds

  • Cash and Investment assets

  • Real Estate

  •  Highly Appreciated property

After Your Divorce

Going through a divorce is exhausting. So when it is final, it may be tempting to retreat and perhaps even shut down. Still, there are many tasks yet to be done to secure your future. And taking control can be therapeutic and help you move forward. 

 Here are some of the most important:

✓ Get certified copies of your divorce order from your attorney and:

▪ Change the deed if you’re keeping the house and transfer the title to your car if it is in both your names.

▪ Update your will and review any trust documents you may have. Change your beneficiary on any life insurance policy, pension plan, retirement account, securities account with a transfer-on-death beneficiary and payable-on-death bank account.

✓ Make sure your vehicle is properly insured and that you’re the only owner listed on the policy.

✓ If you were still married by the last day of the year, you may want to talk to a tax professional to determine whether it is more advantageous to file “married filing separately” or “married filing jointly” – provided it wouldn’t be difficult to work with your ex.

✓ If you claimed a withholding exemption for your spouse, update your W-4  within ten days of your divorce becoming final.

✓ Verify all credit cards, bank accounts and loans are separated. Change passwords.

✓ To avoid taxes or penalties if you are receiving funds from your spouse’s 401(k) or IRA, make sure the transfer is completed in a timely manner.

✓ If you were on your spouse’s health insurance policy, make sure you find individual coverage immediately. A divorce is considered a life event that qualifies you to sign up for insurance on the government health exchange or your employer’s insurance outside their open enrollment period. You can also extend your coverage on your ex-spouse’s policy through COBRA for up to 36 months, but it may be rather expensive.

✓ If you have children and don’t have a life insurance policy, get one.

✓ If your ex-spouse is providing alimony or child support, you may want to consider taking out a life insurance policy on your ex to protect that income.

✓ Because you no longer have a spouse to rely on if misfortune hits, start setting aside funds for an emergency fund if you don’t have one. Similarly, consider disability and long-term care insurance if you don’t have them. 

You may also want to set up a health care proxy and a power of attorney in the event you can’t make your own decisions.

✓ Get a corrected Social Security card, new driver’s license, vehicle title and registration if you changed your name. You’ll also need to update your state tax records, voter record, passport, retirement accounts, insurance policies, mail and utilities.

✓ Work with a fee-only Financial Planner  and Certified Divorce Financial Analyst to determine how much you need for a comfortable retirement and what you need to do to get there. They can help create a budget, set up an automated program that directs funds from your bank into investment accounts and create strategies designed to balance growth potential with the need for secure, liquid investments during retirement years. 

Avoid these 10 mistakes during your divorce

Since most people going through a divorce are not experienced with the process and are battling difficult emotions at the time, financial mistakes are common. Here are some of the pitfalls frequently encountered.

 Not having enough cash on hand.

 With legal fees, court costs, a potential move and no longer sharing living expenses, divorce is costly. So it’s important to have reserves to avoid incurring debt.

 Not securing an income.

 If you’re currently not working, try to get a job (ideally one with health insurance) – unless you expect to walk away with sufficient resources to support yourself the rest of your life. If you are working, look for ways to advance in your career or increase your income since many divorcing individuals find they need at least a 30 percent increase in income to maintain their present standard of living.

Not separating financially.

You can’t control your financial destiny as long as you share a bank account, credit card, car loan or mortgage with your spouse. But if you don’t already have an individual credit card, make sure you can get one before closing your joint accounts. And update your will and change your beneficiary information on your insurance policies and retirement accounts.

Overlooking debts.

If you live in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), you’re liable for half of your spouse’s debt even if it’s not in your name. In the remaining 41 states, joint account holders on credit cards or loans are usually equally liable. So it’s important to close joint accounts and get a full credit report for you and your spouse.

Overlooking assets.

Insist your spouse provide documents for their financial assets. Have your home and valuable possessions appraised. If you don’t know how much a spouse’s business makes, consider hiring a forensic accountant. If your spouse has a pension, it may be wise to have it valued as well.

Expecting an attorney to know and do everything.

Many attorneys do not possess advanced financial training and expertise. An experienced financial divorce planner can provide a unique educated outlook toward the future that examines all the angles. What may seem equitable today may not look that way in years to come in light of inflation, cost of living adjustments, tax implications or other issues.

Not considering all the implications of proposed settlements.

t’s easy to choose to keep the home without thoroughly evaluating whether you can afford all of the expenses that go along with it. Some assets have greater tax consequences than others. For example, stocks may incur capital gains taxes when sold, while profit from the sale of a primary residence is exempt up to $250,000 for a single individual.

Not dividing retirement accounts wisely.

 With different types of plans and various rules and options that apply to each, this is a complex area where a lot can be at stake. A qualified domestic relations order (QDRO) is required to transfer funds from a qualified plan such as a 401(k), profit sharing or defined benefit plan. If it’s possible, a buy-out or trade may work better for an annuity or nonqualified plan. For more information on this topic, see “Splitting Retirement Nest Eggs During Divorce” and “Divorce and Annuities.”

 Not having a post-divorce plan.

 By the time we’ve hit middle age, many of us have developed spending habits and grown accustomed to a standard of living. But a late-life divorce not only divides existing assets, it reduces income – even if one spouse’s primary income is Social Security benefits. A financial advisor can help you determine what you need to retire comfortably and create strategies designed to help you get where you need to be.

 Investing too conservatively or aggressively.

 Once the reality of having less assets while footing all of your living expenses sinks in, it may be tempting to either put too much money in high-risk investments for their growth potential or to choose overly safe investments with low returns.

 An experienced financial advisor can help you make practical, objective decisions during a turbulent time, consider long-term implications of various settlement proposals and reduce the possibility of future financial regrets.

Dividing Assets in Divorce

Few times of crisis require immediate, clear-headed financial thinking like a divorce. From the time of the split to the signing of the settlement, both parties will face making those decisions in a whole new context – alone and with a potential adversary. Even in the most amicable split, the decisions about who gets what come with a mountain of emotional baggage.

---

Knowledge, as Sir Francis Bacon wrote in the 16th century, is power, so arm yourself by gathering every scrap of information on your finances. Request your credit report – you are entitled to one free copy a year from the three major reporting agencies – to check what you and your spouse owe. Open individual bank, credit card and brokerage accounts. Close all joint accounts – a sometimes tricky task if those accounts are sizable. Your attorney can help make sure you get your share of liquid assets.

At some point, one or both of you will leave the family home. This can be the most agonizing split because of the emotional bonds the home represents. Women often want to keep the house, perhaps to spare children from a disruptive move or because they perceive it to be the most valuable asset the couple owns. But that also means keeping the mortgage payment, home owner’s insurance, property taxes, utilities and upkeep – all on one salary instead of two.

During a time of turbulent emotions, it’s essential to rely on your personal team of professional advisors and get first-hand information. Along with your divorce attorney, your team may include an accountant, financial professional and possibly an insurance agent. This team will review your financial situation and make recommendations on possible courses of action. If you’re paying by the hour, don’t use these people for emotional support – call a friend instead.

A new budget can help head off the “splurge to purge” temptation. You need extra TLC, but find ways that don’t cost money. Get used to your new reality of running a household on one salary, and avoid the pitfall of using credit now thinking you can pay it off with your settlement money.

  If your assets as a couple include investments, a business or items like antiques or collectibles, you’ll need a clear view of their value as well as any hidden costs. For example, you may pay taxes on capital gains when you sell stocks, and those gains can vary depending on the purchase price, or cost basis. You may need the help of an investment professional, appraiser or forensic accountant to ensure that what equitable on paper will be fair when the settlement is finalized and later when assets are liquidated.

---

There’s no single best way to split assets during a divorce. Your best defense is to be informed about your assets and liabilities and to select a team of professionals to help you weigh the pros and cons of different options for splitting those assets and liabilities. Take a long-term view of self preservation, not a short-term view of punishment or least conflict. Once the divorce has been settled, you won’t get a chance to ask the judge to reconsider if you find you’ve made the wrong choices.