Divorce and Taxes: 5 Essential Tips for Avoiding Future Financial Woes
Tax season is upon us once again, so what better time to broach the subject of divorce and taxes? According to Connatser Family Law Attorney Aubrey Connatser, “One of the first things we recommend to clients seeking a divorce is: Hire a reputable financial advisor who can advise you about tax and other financial issues during the divorce process. You need to plan in advance, not after the fact.”
Connatser Family Law asked Todd Amacher, J.D., MBA, CPA, CFP ®, CDFA (TM) to weigh in on some of the key tax and financial considerations people should take into account when preparing to divorce. Among his many specialties as a managing director at Robertson, Griege & Thoele Financial Advisors, Todd helps people going through divorce analyze cash flow, tax and other financial ramifications involved with divorce settlements. He encourages people considering divorce to:
1. Do your due diligence when hiring a financial advisor.
“At the outset, it’s very important to do your due diligence when hiring a financial advisor. Along with a recommendation from your divorce attorney and other references, you should also verify the advisor’s credentials and the reputation of the firm he or she is associated with,” Todd says.
For example, is the advisor a CPA (certified public accountant), which is a vital necessity for analyzing tax issues, and has the advisor earned any financial advisor certifications, such as the Certified Financial Planner designation? Hiring an advisor with experience handling complex property settlements in Texas and who understands the tax implications involved in different types of asset classes is essential for couples splitting a sizeable estate.
Learn more about due diligence with this helpful tip sheet from Robertson, Griege & Thoele. CLICK TO DOWNLOAD
2. Begin the divorce planning process with a financial plan.
“In each divorce, especially for the non-monied spouses, we strongly suggest running a financial plan to help them make better long-term financial decisions,” says Todd. A thorough financial plan can also be an invaluable tool during the divorce process.
According to Todd, “The goal is to look at your potential divorce settlement assets and liabilities as well as your future income and expenses and project out how things may play out after divorce. We’ll help clients answer questions such as, ‘Can you afford the house, how many years can you live on your divorce settlement, will you need to downsize, do you need to go back to work?’ All of these questions can help you address the ‘Am I going to be OK question.’”
While statutory alimony is not often awarded in Texas divorces, it’s important to keep in mind that alimony is considered taxable income to the recipient, and you need to account for that. The $10,000 monthly alimony you agree to receive may only amount to $8,000 when taxes are factored in.
3. Look closely at the cost basis and tax burden associated with assets when preparing your balance sheet.
In Texas, the marital estate is subject to division under Texas community property statutes, which means a couple is required to divide all community property, assets and debts upon divorce. Preparing a thorough balance sheet is critical to this process, but it isn’t as simple as listing assets and debts.
“When you’re putting together a balance sheet, you shouldn’t just list your assets. You really need to look at the cost basis of each asset, so you’re comparing apples to apples. For example, when you divide up the balance sheet 50/50, if one person were to get $1 million in cash and the other receives $1 million in stock, you need to take into account what the stock proceeds will actually be worth after paying capital gains taxes.
If the stock proceeds are actually worth .75 cents on the dollar, the person receiving cash would need to give up some of the cash or other assets to meet the 50/50 settlement. An experienced tax accountant or financial planner can help you drill down on the cost basis and the tax laws associated with the assets in the marital estate,” explains Todd.
4. Don’t let an emotional attachment to your home undermine your divorce settlement.
Frequently, one party in a divorce would rather walk away with the family home instead of cash, but for some this can be a costly mistake. “Try not to get too emotionally attached to your house or overvalue it because of the capital gains exception. Often people end up being house rich and cash poor. Houses shouldn’t be looked at as an investment, but a place to live.
If your investment portfolio drops, and you need to sell your house, you may end up selling your house for less than it was worth at the time of the divorce settlement. You don’t want to be in a position, as many homeowners were in the recent past, where your home either loses value or buyers are scarce. Instead, it may make more sense to ensure access to liquid assets in your divorce settlement.” Todd says.
5. Avoid future money disputes by planning ahead.
It isn’t uncommon for divorcing couples to overlook certain assets when separating property (either by accident or on purpose). Prepare yourself for the likelihood this will occur. According to Todd, “If you can agree in advance how you will handle assets that were overlooked, you may be able to avoid going back to court.”
Todd also finds, “many couples often forget to plan for kids’ needs as they get older, such as transportation, car insurance, college, weddings, cell phone bills and other expenses. Once your kids are of age, the court system typically can’t force you to cover certain expenses, but that doesn’t mean divorced couples won’t fight about them.”
If you cover how specific, future expenses will be handled in your divorce decree, then you and your spouse should be contractually bound. “These instances are what I sometimes see people fighting about post-divorce. By planning ahead, you can avoid many financial disputes, that might otherwise land you back in court,” says Todd.
Assemble a Trustworthy Team of Advisors
At the end of the day, Todd’s biggest piece of advice is to make sure you hire good advisors. “Many people reach a settlement and end up with a financial advisor who doesn’t have their best interests at heart, but would rather sell financial products or services people don’t need. If you do your due diligence, assess your financial goals early on and have experienced advisors by your side, you may be able to avoid putting your long-term financial health at risk.”
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The above content is provided for information only and should not be construed as tax, legal or financial advice. Contact a reputable tax, legal and/or financial advisor for advice pertaining to your individual circumstances.