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Divorce can be quite a traumatic time for both parties involved.
Often the last thing anyone even considers is the actual tax implications of said divorce on each partner.
I thought this was a not often talked about subject matter in the financial blogosphere and hoped to rectify this.
Beth Logan, EA, a federally licensed tax practitioner who has authored the book, “Divorce and Taxes: After Tax Reform,” graciously offered to shed some light on the subject matter.
[Disclaimer: Besides the use of the book affiliate link (with no extra cost to you), Beth Logan and I have no financial relationship.]
We’ve all met that divorcing spouse that is so focused on the child custody that others things get missed.
We also know the vindictive spouse going through a divorce.
While these are the more extreme reactions to divorce, emotions play a large part in the divorce process and often to the detriment of the couple’s finances.
Case Example A:
Recently, I helped out with a divorce involving two children.
Each spouse was going to claim one child because that was only fair.
But what does this actually mean?
Well, in this case, a worse financial situation and not much more.
Kelly was fighting for more money.
Drew was fighting for more of the payments to be considered alimony.
This is because in divorces before 2019, the alimony is deductible on the tax return of the payer.
The custodial arrangement was already decided and Kelly would have the children about 60% of the time.
As a neutral third party, I looked at the situation.
Drew could not claim Head of Household because Drew did not have either child for 50% of the time.
Also, Drew’s income was too high to claim the child tax credit.
Therefore, there was no financial benefit in Drew claiming either child.
Instead, Kelly was able to claim both children, resulting in an additional $2,000 tax credit.
Because Kelly was getting the $2,000 tax credit, Drew could reasonably argue that payments to Kelly could be adjusted.
Case Example B:
When working with another divorcing spouse, there was a strong desire to split the assets equally.
Equally is not always equitably.
Chris was in a vindictive mode causing Terry to want the whole divorce to just end.
I showed that both would be better off dividing the assets based on after-tax value.
In their haste to end the process, they divided the assets essentially in half but leaving Chris with the house.
The problem with this couple was that Chris had no income.
Terry ended up selling stock causing a capital gains tax issue.
Chris, who could have sold the stock over a few years and paid no tax, ended up the with house.
Instead, Terry could have transfer the investment account to Chris.
Then Chris could sell the stock as money was needed.
The tax rate on the stock sale would be 0% or 15% instead of the 20% that Terry paid.
Additionally, if neither spouse was planning to keep the house, then it should have gone to Terry and other taxable assets to Chris.
Selling the house would have been a tax free event for either of them.
The other assets with taxable income would appear on Chris’s tax return which has lower taxable income and therefore, lower taxes.
Overall, the couple could have left the marriage with more money if good tax planning was followed.
The US and state governments received tens of thousands of dollars in taxes thanks to the couples emotional approach.
It is perfectly reasonable to have strong emotional reactions during a divorce, but they need to be compartmentalized.
To avoid financial pitfalls it is essential to set some time aside to be practical.
It may be valuable to have a neutral third party look at the financial situation and provide ways for both spouses to benefit using taxes strategies.
In the long run, having the strongest possible financial situation will allow both spouses to move forward in their respective lives and will help any children as well.
Beth Logan, EA
Author, Divorce and Taxes After Tax Reform
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