Dividing Assets: What to Do in a Divorce
One of the most difficult aspects of divorce, after custody issues, typically concerns the division of marital assets. While in recent years the courts have tried to make this process of splitting up assets in a divorce simpler and fairer, divorce can create many complex legal and taxation issues. According to the Michigan Association of CPAs, it is imperative that both parties in a divorce seek the advice of qualified professionals who can help address the critical financial issues involved when ending a marriage.
The State Of Divorce
In most states, assets subject to legal division include almost everything a couple has accumulated during their marriage — investments, homes, retirement plans, and other employee benefits as well as personal effects such as cars and furniture. Laws governing the legal division of property vary depending on where you live.
In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the assets acquired during marriage are automatically divided equally. In the other states and District of Columbia, equitable distribution is the method used to divvy up assets. The criteria for establishing equitable distribution may include the length of the marriage, the earnings potential, health, and education of both spouses, whether they have children and with whom they will reside, as well as the financial and non-monetary contributions each partner brought to the marriage.
Divorce Can Be Taxing
For most divorcing couples their investment portfolios, home and retirement plans are the largest assets to be considered. To create a property settlement that serves your present and future needs, you must prepare a solid accounting of the after-tax value of your assets. If the property division is determined without regard to taxes, what appears on paper to be a fair settlement can, in actuality, be very one-sided.
Appreciated investments come with a tax liability. From a net-of-tax viewpoint, this means that appreciated investments are worth less than an equal amount of cash or property that has not increased in value. If the objective is to split everything 60/40, you should reduce the value of any appreciated investments by the built-in tax liability and use those net-of-tax values to arrive at the desired 60/40 split.
House of Taxes
Selling a home can have significant tax ramifications for both parties in the divorce. With proper planning and professional advice, couples going their separate ways may be able to avoid unnecessary capital gains taxes. Under the Taxpayer Relief Act of 1997, if your house was owned and used as a principal residence for at least two out of the five years before the sale, you may immediately exclude up to $500,000 if filing jointly, or $250,000 for single filers. Special rules apply to ex-spouses who retain ownership but do not reside in the home.
Retirement Accounts and Stock Options are Marital Property
Whether it’s a pension or profit sharing plan, a 401(k) or a Keogh, the money that accumulates during marriage in a retirement account is considered a marital asset and, therefore, is generally divided between divorcing spouses.
In order to obtain a share of your spouse's retirement plan assets, you must submit a qualified domestic relations order (QDRO), to your spouse's benefit plan. A QDRO is a court-ordered disposition of marital property that establishes an ex-spouse’s legal right to receive a designated percentage of his or her former spouse’s qualified plan account balance. A word of caution: Without a QDRO distributions to a spouse become fully taxable to the plan owner and a 10% penalty on withdrawals before age 59 1/2 may apply.
Among other employee benefits, stock options are increasingly becoming the focus of many divorce negotiations. Experts tend to disagree on the best way to divide stock options, especially since it is often difficult to determine their precise value. Since a QDRO does not apply to stock options, the dissolution of this benefit must be included in the divorce agreement.
There is no doubt that tax implications can complicate the already painful chore of splitting joint assets. Consulting with a CPA can help ensure that you minimize taxes when dividing the family treasures.
You seek the expertise of CPAs at tax and audit time, of course. But CPAs also promote personal and professional financial security year round. Visit the CPA Referral Service on the MACPA website to search for a CPA in your geographical area or specific area of expertise.
This article was submitted by the Michigan Association of CPAs.