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.

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.