Why should I understand The Effect of Tax Benefits on Divorce?
Many attorney fail to address tax issues during a divorce. This can result in their clients leaving considerable money on the table. Or, if the case goes to trial, the failure to demonstrate these issues to a judge can cause a detrimental judgment. It may be important for you to understand “The Effect of Tax Benefits on Divorce” to make sure your attorney is addresses them.
The Effect of Tax Benefits on Divorce
The first one, capital gains, is fairly easy. If you have a profit when selling a property, then you pay taxes on that profit. For example, if you and your spouse own a rental property that you purchased years ago for $350,000 and that is now worth $600,000, then that property has a capital gain of $250,000. When the property is sold, you will pay a tax on the gain (not the entire price. Under current tax law, the capital gain tax is 15%. (The capital gain rate could be from 0% to 20% depending on the amount of the gain. I will use the 15% rate as it is correct for this amount of gain and applies to gains up to $479,000 for a married couple filing jointly.)
Thus, if there is a rental building in the community property, with the above listed values, then the tax would be 15% of $250,000 or $37,000. Now, let’s assume that there is an additional property but it was bought just last year for almost $350,000. When the spouses get around to negotiating their property settlement, those properties, which have identical current values, have substantially different actual values to the spouse receiving it. If you do not take the tax effect into consideration, then the spouses might just agree that one will get one property and the other will get the other property. After all, each of them got something worth $250,000, right? No, one of them got something worth $250,000 and the other got something worth $212,500 (the value less the taxes to be paid.) Your attorney needs to help you to understand the tax implications of all property settlements so that you do not get the wrong end of that deal.
Understand The Effects of Investment Accounts on Divorce
The second frequently encountered issue involved tax-advantages investment account such as IRAs and 401(k)s. These can invoke several traps for the unwary.
First, these accounts come with a significant amount of money in them that belongs to the government. That is the taxes that were not paid (except in a Roth IRA) and interest. When the money is eventually withdrawn, those taxes will be paid. Depending on the age of the account, the amount provided by the employer, the increase or decrease in value of the investments in the account, and other items, two accounts that appear to be equal could be far from it when taxes are considered.
Second, one or both accounts could include money that is separate property rather than community. It is possible that most of the money in one account was acquired before marriage, but all of the funds in the other account were acquired during the marriage. Treating them equally is simply an unnecessary give away of separate property, but I have seen it happen many times.
Third, your attorney might not know to evaluate the value and income within the account. For example, let’s assume that early in your employer’s history, and before you got married, you received a lot of stock in the company in your 401(k). After all, it was low-priced at that time and they could afford to pay you a lot of it. Later your employer went public. That may have greatly increased the value of the stock, but slowed the future annual increases. Then you got married. During the marriage, you still received stock, but not as much and it has not increased much since then. You might have a serious job to trace what is yours and what is not. For example,
What is your separate property?
- The stock that you originally received
- The increase in value of that stock, both before and after marriage
- All stock dividends, both before and after marriage
- All stock splits both before and after marriage
What is your community property that partly belongs to your spouse?
- All stock received after the marriage
- All increase in value of that stock
- All cash dividends from after marriage
- All interest or other income
This is not easy to trace and will require that you have or can obtain significant information about the various transactions, perhaps going back several years. Not only that, but you have to prove that it is separate property by “clear and convincing evidence” and that is a high standard. Finally, you have to ensure that all of your evidence is properly authenticated and admissible and that is often extremely tricky. No one plans on getting a divorce. Keeping significant information on various transactions is much easier then going back several years to trace them.
It is important to make sure that your attorney is well-versed in the effect of tax benefits on divorce. Bob Leonard is a Board Certified Family Law Specialist with decades of experience in Business and Finance. Contact a qualified divorce attorney today.
This is the last of three articles on taxes and divorce. The first two discussed major changes due to the new tax bill recently passed by Congress. This one addresses issues that have been with us for a long time.