9 Questions You Must Ask Yourself Before You Get Divorced

Estate Planning Advice
for Every Stage of Life.

9 Questions You Must Ask Yourself Before You Get Divorced

Divorce is a painful, emotional experience, and without proper planning, it can also be a disastrous financial event. Once certain decisions are made involving your assets, there is no way to change them. Following are some valuable questions you must consider to ensure your family is well taken care of.

      1. How much will it cost to live after the divorce? Will you be able to financially survive?
      2. Will alimony be paid and for how long? (Keep in mind that    alimony is deductible by the spouse paying it and taxable to the spouse receiving it.) What about child support?
      3. Which parent will get to claim the dependency exemption for the children?
      4. What about financing the children’s college educations?
      5. Should one spouse keep the house?
      6. How will your retirement accounts be split? (It’s critical to discuss a “Qualified Domestic Relations Order,” which establishes a legal right to a portion of a retirement plan and ensures that your ex-spouse is responsible for paying the income taxes on any distributions that he or she receives. Without a QDRO, you could wind up paying the tax bill.)
      7. Are there potential hidden assets?
      8. If you or your spouse owns a closely-held business, how will it be valued?
      9. What are the tax consequences of property settlements?

These questions are a good place to start as you’ll discover many more during this long ordeal. Always keep in mind that once a divorce settlement is final, you will be unable to change many of the provisions.

PERKINS & ZAYED, P.C.
1745 South Naperville Road, Suite 100
Wheaton, IL 60189
Phone: 630-665-2300 | Toll Free: 877-TRUST-50
Fax: 630-665-4343
Email: admin@trust-lawgroup.com
The information contained on this website is for informational and educational purposes only and is not legal, tax or financial advice. Always consult a qualified licensed attorney and/or appropriate professional to provide advice for your individual needs and circumstances. Use of this website does not create or constitute an attorney-client relationship. This website may include advertising material for Perkins & Zayed, P.C., The Estate and Trust Law Group. 

5 Commonly Asked Financial Questions During Divorce

Estate Planning Advice
for Every Stage of Life.

5 Commonly Asked Financial Questions During Divorce

Divorce involves more than just heartbreak and hassle. Your life savings, financial security and future earnings are also at stake. Don’t leave settlement of the marital estate to the discretion of your soon-to-be ex-spouse or the court. Take charge of your financial well being by knowing your rights, obligations and risks in divorce. Here are answers to five commonly asked questions.

1. What’s included in the marital estate?

Not every asset that you or your spouse owns is part of your marital estate and, therefore, divisible when you get divorced. What’s included in your marital estate is a function of many factors, such as:

      • Prenuptial agreements;
      • A comparison between the asset’s acquisition date and your wedding anniversary;
      • Each spouse’s contribution to the asset or participation in the asset’s management during the marriage;
      • State laws and legal precedent; and
      • Whether the asset has been combined with other marital assets.

For instance, a piece of real estate acquired prior to your wedding may be specifically excluded from your marital estate if you signed a prenuptial agreement. But it will likely be included in your marital estate if you used marital funds to pay for landscaping and improvements on the property for the past ten years.

When it comes to business interests, the value to include in the marital estate can be even trickier. Only the appreciation in value during your marriage may be included if a spouse owned the interest prior to the marriage, for example. But if you contributed additional capital from your joint checking account, a court might rule that the entire business interest should be included in your marital estate.

In addition, goodwill may require special treatment. About half the states specifically exclude personal goodwill — the value inextricably tied to the owner as an individual — from the marital estate if alimony is awarded. The rest of the states either include or exclude all goodwill in the marital estate. When little relevant case law exists about how to handle goodwill in your state, courts sometimes look to other states for guidance.

What your marital estate includes (or excludes) varies from state to state, so pick your venue carefully if you have options. To illustrate, one wife moved across state lines with her children to the couple’s vacation home to establish residency in a jurisdiction that favors her financial interests and custodial rights.

2. Could my ex be hiding assets?

When divorce turns ugly, people worry that an estranged spouse will hide assets. A classic example is the cheating husband who buys real estate and jewelry for his mistress using marital funds. But male or female, rich or poor, self preservation may cause normally honest people to hoard assets. So, always be on the defensive.

If an asset goes missing or the numbers don’t add up, hire a forensic accountant. He or she can do a title search for undisclosed assets under your ex’s social security number. Forensic accountants also can evaluate income and expenses to determine whether everything appears legitimate.

3. What’s the real value of each asset?

Cash is king. You know what cash is worth, and you can spend it immediately. But what about your house, jewelry, retirement funds or business interests? The value of these assets is more subjective and less liquid.

Consider your house. Many people want to continue living in their home after the divorce, especially if they have children. But moving — and letting go of your emotional ties — may be better for your financial well being. The current real estate market is uncertain, and you risk having your property over-appraised. Plus if times get tough and you need cash, you may not be able to sell your house and downsize quickly. And banks are stingier about home equity lines of credit these days. A lump sum in cash might be a safer bet than real estate.

Retirement funds and private business interests are even harder to convert into cash. You generally cannot access your retirement until age 59 and 1/2 without incurring a 10% penalty. If you are currently, say, 40 years old, this can be a long time to wait.

Business interests may be subject to transfer restrictions or built-in capital gains tax. Suppose you own an interest in an S corporation; you are personally responsible for the company’s tax obligation, even if you receive no cash distributions to fund your tax bill. Plus it takes time and effort required to sell private shares, especially when you receive a minority interest.

The bottom line: Not all assets are equally desirable when settling your divorce. Consider the risk, liquidity and tax consequences of the asset mix you take away from the marital estate.

4. How much maintenance will be awarded?

There are two types of maintenance payments awarded in divorce cases: child support and alimony. Child support is an amount paid to the custodial parent to raise a minor child. It is usually based on a statutory percentage of the noncustodial parent’s annual income.

For income tax purposes, the noncustodial parent cannot deduct child support payments, and the custodial parent does not claim child support as income. Your settlement agreement should also specify who can claim dependency exemptions and tax credits for minor children, as well as who pays for college and health insurance.

Alimony payments are not a sure win. They are affected by many factors, including:

      • Prenuptial agreements,
      • Length of your marriage,
      • Your status and standard of living, and
      • Education, skills and earning capacities of both spouses.

The spouse who pays alimony can usually deduct it from adjusted gross income. If so, the recipient must claim alimony as taxable income. Alimony may be temporary until the non-monied spouse receives some training or education. Or it can last indefinitely until the non-monied spouse remarries.

All maintenance is based on the payer’s income, so reasonable replacement compensation is important to assess. If an unscrupulous person intentionally underpays himself or herself, court-awarded maintenance payments may be inequitable or insufficient to cover post-divorce expenses.

5. Will I have enough money to pay all my post-divorce expenses?

Financial independence can be scary. Some people getting a divorce have never held a job, paid a bill or individually met with a CPA in their lives. Others are uncertain how to invest the cash they’ve been awarded. Budgeting is a step in the right direction.

Creating a monthly household budget starts by brainstorming all sources of cash from alimony and child support receipts, salaries, investment income and gifts. Then estimate all your expenses, such as child support and alimony payments, household and vehicle costs, vacations, child care and health-related costs. As long as your income outpaces your expenses every month, you’re in good shape. If not, you should have sufficient savings available for any shortfalls.

The most important step in the budgeting process is comparing the budget to your actual income and expenses. This comparison tells whether your budget is complete and accurate. It also lets you know whether your spending is out of control. If you can’t get a handle on your finances, your financial advisor can help.

AN OUNCE OF PREVENTION

Even the most amicable situation can turn adversarial if one party suddenly becomes greedy or suspects foul play. The best way to protect your financial interests is to communicate openly and freely share financial information with your former spouse.

Before you file for divorce — or as soon as you are served divorce papers — go through your financial records and make copies of relevant documents, such as:

– Bank, investment and retirement account statements;
– Mortgages and lines of credit;
– Personal tax returns;
– Home appraisals and closing documents;
– Legal contracts, such as shareholder agreements, leases and employment      contracts; and
– Corporate financial statements and tax returns, if applicable
PERKINS & ZAYED, P.C.
1745 South Naperville Road, Suite 100
Wheaton, IL 60189
Phone: 630-665-2300 | Toll Free: 877-TRUST-50
Fax: 630-665-4343
Email: admin@trust-lawgroup.com
The information contained on this website is for informational and educational purposes only and is not legal, tax or financial advice. Always consult a qualified licensed attorney and/or appropriate professional to provide advice for your individual needs and circumstances. Use of this website does not create or constitute an attorney-client relationship. This website may include advertising material for Perkins & Zayed, P.C., The Estate and Trust Law Group. 

Dividing Assets – And Tax Bills – in Divorce

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for Every Stage of Life.

Dividing Assets – And Tax Bills – in Divorce

How assets are split up in a divorce depends largely on where the divorcing couple lives. The following nine states are community property states: California, Texas, Washington, Wisconsin, Arizona, Nevada, New Mexico, Louisiana, and Idaho. In these states, the general rule is that community property assets (i.e, assets accumulated by the couple during their marriage) are considered to be owned 50/50. Assets that were owned by one spouse before the marriage, or that were received by one spouse as a gift or bequest during the marriage, are generally considered to belong solely to that person.

All the other states except Mississippi are so-called equitable distribution states. In these states, the general rule is that the divorcing couple’s assets are divided according to “whatever is fair” in the opinion of the divorce court. As a practical matter, this often works out to be a 50/50 split. However, a 50/50 split is not mandated by law in these states. (In contrast, a 50/50 split generally is mandated by law in the nine community property states.) Of course, a divorcing couple can also agree out of court on their own version of “what is fair.”

In Mississippi, the general rule is that each spouse walks away with the assets that are titled in his or her own name.

Divorce Tax Basics

Now let’s talk about the federal tax aspects of divorce. The general rule is that the division of property, including cash, between divorcing spouses has no immediate federal income tax or federal gift tax consequences. Why? Because Section 1041(a) of the Internal Revenue Code generally mandates tax-free treatment for transfers between spouses of real estate, personal property, investments held in taxable accounts, business ownership interests, and similar assets both before the divorce and at the time the divorce becomes final. Such transfers are considered gifts between spouses. As such, no federal income tax or federal gift tax is due.

This same tax-free treatment also applies to post-divorce transfers between ex-spouses if they are made incident to divorce. Transfers incident to divorce mean those occurring within:

1. One year after the date the marriage ends, or
2. Six years after that date as long as the transfers are made pursuant to a divorce or separation agreement.

When a transfer falls under the tax-free transfer rule, the spouse (or ex-spouse) who receives the asset takes over the existing tax basis in the asset (so a carryover basis rule applies). The spouse who receives the asset also takes over the existing holding period for the asset (in other words, a carryover holding period rule applies).

Important: The tax-free transfer rule doesn’t automatically apply to tax-advantaged retirement accounts (you must jump through some hoops to get tax-free treatment). Also, the tax-free transfer rule is inapplicable to taxable investments to the extent of accrued ordinary income (more on that later). Finally, the tax-free transfer rule doesn’t apply when the spouse who receives the asset is a nonresident alien.

Although the tax-free transfer rule applies to most divorce-related asset transfers, the federal income tax implications are still extremely important. Why? Because the spouse who winds up owning appreciated assets (fair market value in excess of tax basis) under the tax-free transfer rule must recognize taxable income or gain when those appreciated assets are sold (unless some exception applies, such as the exclusion for gain on sale of a principal residence).

Key Point: When one spouse ends up with 50% of the couple’s assets in the form of cash while the other person ends up with 50% in the form of appreciated assets, guess who got the short end of the stick? The person who received the appreciated assets, that’s who. For this reason, divorce property settlements should be based on net-of-tax values (fair market value of assets reduced by any built-in tax liabilities). That way, the agreed-upon split (50/50 based on net-of-tax values, or 60/40 based on net-of-tax values, or whatever) won’t create any unexpected or unfair tax outcomes for either party.

Splitting Up Investments Held In Taxable Accounts

Under the tax-free transfer rule, divorcing spouses can usually make tax-free transfers of investments held in taxable accounts (or in a safe deposit box or under a mattress for that matter) while they are still married or when the divorce becomes final. The same is true for post-divorce transfers between the parties, provided they are made incident to divorce, as explained in more detail in the right-hand box.

Remember: After a tax-free transfer, the recipient spouse’s tax basis in the investment is the same as before and so is the holding period.

Example: Let’s say your divorce property settlement calls for your soon-to-be-ex-spouse to receive all of your long-held stock shares. Assume the tax-free transfer rule applies. Accordingly, there’s no immediate tax impact on either you or your spouse when the shares are transferred. Instead, your spouse just keeps on rolling under the same tax rules that would have applied had you continued to own the shares (i.e., carryover basis and carryover holding period).

The same results would apply if the stock shares were:

      • Held as community property.
      • Jointly owned by both you and your spouse.
      • Owned solely by your spouse. In any of these cases, when your spouse ultimately sells the stock shares, he or she (not you) will owe any resulting federal capital gains tax.

That’s the catch. When you are the one who winds up owning appreciated investment assets, you will ultimately owe the built-in tax liability that comes attached to those investments. The bigger the appreciation, the bigger the tax bill. So from a net-of-tax point of view, appreciated investments are worth less than an equal amount of cash or other assets that have not appreciated.

Key Point: You and your soon-to-be ex-spouse should use net-of-tax figures to arrive at an equitable property settlement. For instance, let’s assume the objective in this example is to divide everything 60/40 in favor of your spouse. In arriving at the 60/40 split, the value of any appreciated investments held in taxable accounts should be reduced by the applicable built-in tax liabilities.

Beware Of Investments With Accrued Ordinary Income

According to the IRS, the tax-free transfer rule generally applies only to what might be termed “capital-gain assets.”

In contrast, when you transfer investments with accrued ordinary income (for example, taxable bonds between interest payment dates, stock shares after the ex-dividend date but before the dividend payment date, U.S. Savings Bonds with accrued interest, and the like), you are taxed on the accrued ordinary income as of the date of the divorce-related transfer.

Conclusion: Like any other major transaction, a divorce can have tax implications so it’s important to consult with your tax advisor before making any related agreements.

After Divorce: Only Certain Transfers are Tax Free

Special care is required for post-divorce transfers of appreciated assets to an ex-spouse. Such transfers are tax-free only if they are considered incident to divorce

Within one year after the divorce, transfers automatically pass this test. For a later transfer to be considered incident to divorce, it must be shown that the transfer is related to the cessation of the marriage. This generally means the transfer must: 

    1. Occur within six years of the divorce.
    2. Be required under the divorce property settlement agreement (including any post-          divorce amendments to said agreement). 

If you plan to transfer appreciated assets to your ex-spouse more than one year after the divorce, the divorce papers should clearly identify such transactions as being part of the property settlement. Otherwise, you could be treated as making a taxable sale or a gift to your ex-spouse. This could result in a tax bill or it could diminish your $11.18 million federal gift tax exemption and your $11.18 million federal estate tax exemption for 2018 (both up from $5.49 million in 2017). 

PERKINS & ZAYED, P.C.
1745 South Naperville Road, Suite 100
Wheaton, IL 60189
Phone: 630-665-2300 | Toll Free: 877-TRUST-50
Fax: 630-665-4343
Email: admin@trust-lawgroup.com
The information contained on this website is for informational and educational purposes only and is not legal, tax or financial advice. Always consult a qualified licensed attorney and/or appropriate professional to provide advice for your individual needs and circumstances. Use of this website does not create or constitute an attorney-client relationship. This website may include advertising material for Perkins & Zayed, P.C., The Estate and Trust Law Group. 

Estate Planning After a Divorce

Estate Planning Advice
for Every Stage of Life.

Estate Planning After a Divorce

During a divorce proceeding, a couple or the court decides how to divide their assets and pay off their debts. The parties or the court also determines custody and child support issues if there are children. When the divorce is finalized, an individual acting prudently should review his or her estate plan to update documents to reflect a new life situation.

Estate planning documents that generally need review after a divorce are:

      • Last will and testament;
      • Living trusts;
      • Power of attorney;
      • Health care proxy (sometimes called a health care power of attorney);
      • Life insurance policies; and
      • Retirement accounts

When you review your will, you need to revise it to change beneficiaries (such as your ex-spouse, if you so desire) as well as review specific bequests of property that you may no longer own due to your divorce. You will have to review who is the designated executor of your will and determine whether to change the designation (the executor could be your ex-spouse and you may not want that).

You need to review any designated trustee for testamentary trust that you previously stated in your will. Also, you may want to change how you distribute assets to your children, if any.

For example, you may believe that your ex-spouse would not properly manage monies you would leave to your children. In that case, as part of your will, you may want to set up a trust which the money will go into, and designate a trustee to manage that money. Perhaps the trustee could be a sibling of yours.

More Points to Consider

Who have you designated as guardian for your children? Generally, if someone who had minor children dies, the other spouse would be the first in line to be the legal guardian, if not already awarded custody of the children. In any event, it would be good to name a guardian for the children in the scenario where your ex-spouse is incapable, unwilling or unable to care for the children. The court would not automatically designate a guardian based on the wishes stated in your will, but will look to your designation as an indication of your intent.

The same is true when you review your “living” trusts. These are trusts wherein you currently have control. Possibly, you had a trust with your ex-spouse. If revocable, in the divorce proceeding, you and your ex-spouse would have revoked a joint trust. If you have a trust in your name or have to create a new one, you may have to change the trustee’s name and revise the assets in the trust due to your divorce.

If you previously had a power of attorney (which designates who handles your finances in the event you become incapacitated or need help in the future), you most likely will have to change the designated attorney in fact. You would also have to change the name of your spouse if you named her or him as your designation to make health care decisions for you in a health care proxy.

Further, you need to review your insurance policies, pension plans, and retirement accounts to make sure that the designated beneficiaries meet the requirements of the divorce settlement or judgment, and meet your current desires.

Consult with your your attorney if you have questions about these issues and you are contemplating, in the middle of, or have completed a divorce.

PERKINS & ZAYED, P.C.
1745 South Naperville Road, Suite 100
Wheaton, IL 60189
Phone: 630-665-2300 | Toll Free: 877-TRUST-50
Fax: 630-665-4343
Email: admin@trust-lawgroup.com
The information contained on this website is for informational and educational purposes only and is not legal, tax or financial advice. Always consult a qualified licensed attorney and/or appropriate professional to provide advice for your individual needs and circumstances. Use of this website does not create or constitute an attorney-client relationship. This website may include advertising material for Perkins & Zayed, P.C., The Estate and Trust Law Group.