5 Things You Don’t Know About the Tax Implications of a Divorce
You’ve figured out who gets the beloved Hermès Kelly bag. You’ve split custody — of both the kids and the dog. The boat’s been sold. And, miraculously, everyone’s feeling pretty amicable. Divorce: it’s not something you ever anticipated, but it’s happening, and you feel prepared.
We just have one question: have you hired a Certified Divorce Financial Analyst (CDFA®) yet?
The truth of the matter is, your attorney can do a lot, but they can’t provide all the guidance you need. Read on to learn the five things you don’t know about the tax implications of a divorce — and why you should hire a CDFA for your own financial security and peace of mind.
1: Be prepared for the long haul
It’s great that you and your former spouse are on good terms now, but you want to make sure you understand the divorce’s full scope of financial impact. Splitting everything down the middle sounds easy, but things are rarely simple, and the process could take longer than anticipated — especially if you want to make sure your interests are being looked after. As soon as you’ve decided on a divorce, equip yourself with financial knowledge by hiring a CDFA. If you know your interests, you have control over how they are handled, giving you the upper hand, preventing you from being blindsided later — no matter how long the “long haul” ends up being.
2: Know your long-term tax liabilities for the assets you’re divvying up pre-divorce
Whether it is interest-free bonds, the house you raised your kids in, your retirement fund, or a timeshare to Walt Disney World, there will be tax consequences and implications for the assets you divide between the two of you.
Often, people look at the fair market value of jointly owned property instead of a property’s tax basis, assuming that this is enough to go on when divvying up. But let’s say you have two different assets you’re splitting “fairly”: stock options and undeveloped land (you never did get around to building that second home together … ). Both assets are valued at the same amount. So, naturally, it makes sense for you to get one, and your spouse to get the other. That is, until one of you sells your asset, and you get a hefty tax bill. This is considered a tax carryforward, and you should understand them before the divorce is finalized.
Tax carryforwards are important to consider when dividing assets because of the tax consequences — and planning opportunities — that could exist in the future. They include carryovers like:
- net operating loss carryovers,
- business tax credit carryovers,
- capital loss carryovers,
- excess business loss carryovers,
- investment interest expense carryovers, and
- suspended passive activity loss carryovers.
Tax regulations give you a great framework, but unfortunately, they do not tell you how these carryovers should be allocated between you and your spouse; instead, you must decide. A CPA should be leveraged to identify the tax considerations, as well as any potential impact they could have on each spouse.
3: Rely on a seasoned professional to gain the full financial picture
You don’t want to think this way, but you need to be prepared for the fact your spouse may have been getting away with unsavory tax practices you were not aware of when you were married. And if so, you need someone on your side. A CDFA can help you gain the clarity and understanding you will need to strategize so you are satisfied with the choices you make during a divorce long after the marriage is dissolved.
For example, imagine your spouse purchased a Mercedes-Benz G-Wagon SUV during the marriage. At the time, you thought everything was above board. But your analyst uncovers that the G-Wagon's full value was written off because of the weight, thus showing a lower annual income — negatively impacting you and your likelihood of a fair division of property and income.
To combat this, your CDFA would provide a lifestyle analysis. This entails scrutinizing everything from tax returns to credit card transactions, which could uncover hidden trails of unreported income or assets in the uncovered discrepancies. The party’s liquid assets may not support their current standard of living with business class flights abroad and stays at the newest Dorchester Collection hotel. An analysis would show the warning signs.
The examinations and reports gathered by an analyst can show both you and your attorneys a clear picture of the financial matters you’re dealing with on both sides, which can contribute to an equitable resolution between parties. This applies whether you settle or go to court. If it’s the latter, your CDFA can be an invaluable witness on your “team.”
4: Conduct a financial analysis early in the divorce process
As we mentioned, projecting financial impacts for both the short- and long-term is critical to understanding how you will be affected by the divorce. Have your CDFA prepare an independent analysis of the tax consequences under different scenarios, so you know possible outcomes. This will not only create a framework for you moving forward, but it will prevent your partner from successfully sneaking around and attempting to pull the wool over your eyes. These financial analyses can also include a review of the last income tax return filed by your spouse.
5: Remember, this service pays for itself
You may be tempted to forgo a CDFA in the throes of your divorce, thinking it’s just another bill to pay. But the truth is, the service they provide does pay for itself. If fraud or misuse is identified at any point in the divorce process, you will save yourself money in the long run having prepared for these tax liability scenarios, and when it comes to figuring out your assets, you will be able to see beyond the current fair market value, so you won’t be blindsided later on.
Our perspective on hiring a CDFA for your divorce
At the end of the day, think of the financial side of your divorce like a puzzle: you need each and every piece in order to complete the picture. While you may be on good terms with your spouse now, things are rarely simple when money is involved. It is far better to see the puzzle in its entirety now instead of picking up a piece that got edged under the sofa later and discovering you’ve been misled or treated unfairly.
Hiring a CDFA purges the emotion from the situation, which is exactly what you must do to ensure your financial security.
At MGO, we can help. Our Private Client Services practice puts you and your story first.