Each year, more than one million U.S. marriages end in divorce. Many people forget to plan for the financial impact of a divorce prior to filing.
There are many financial decisions that you must think about during divorce in order to minimize the financial impacts of a divorce, and few people give thought to these decisions prior to starting the divorce process.
Divorce can be financially devastating for couples due to the legal fees, the division of assets, ongoing support obligations, and the need to make incomes stretch to meet the needs of two separate households. There are also many recent financial and tax developments that you should know about.
You need to be careful to make sure that you are left with an adequate settlement and that you are not left saddled with unmanageable debit or tax issues that crop up many years after the divorce is completed.
Debits and Credit Cards
Although most divorce settlements end up dividing the marital debit, creditors often can legally go after either spouse for payment of debits regardless of what the judgment says. There are countless clients who come in and complain of vengeful spouses who purposefully ruined their credit after a divorce.
Smart consumers will insist on trying to use marital assets to pay off as much debit as possible as part of the divorce settlement. Perhaps you can use the house proceeds to pay off all joint debit prior to dividing the balance of the proceeds.
Another variation — one spouse can refinance the house and keep ownership while paying off debits and buying out the other spouse out of the home equity.
Another idea– credit card offers for low interest cards abound today. Divorcing spouses can apply for new low rate cards in their own name and transfer the balance from various jointly owned accounts to cards in their own name. The joint accounts should be closed to prevent a spouse from continuing to run up debits under both names.
Your House: A Valuable Asset
In 1997 Congress changed the tax law to allow each person to exempt from taxation the first $250,000 in profit from a home sale. This makes homes a more valuable asset since couples could potentially get a $500,000 tax free windfall on the sale of their home.
To take advantage of the tax free gain the seller generally has to reside in the home for at least two of the last five years. And if the parties are divorcing and one spouse is granted exclusive use of the home as part of a written separation agreement or court order, the other spouse is treated as if he or she continued to live there for home for home sale tax purposes.
Most tax credits go to the parent who taxes the exemption for the children. The exemption is a $2,8000 per person write off that’s available for each taxpayer and dependent.
The custodial parent typically automatically receives the exemption unless the court orders otherwise. However, parties can agree to give the exemption to the other parent in their settlement, and the parties then can transfer the exemption by filing out IRS form 8322 on an annual basis.
Transferring these exemptions may lead to overall tax savings for the divorcing couple, meaning more money for both parents.
Don’t Forget to closely look at stock options. Just because they may vest well into the future does not mean that they are not a community asset.
In fact options may often represent a significant marital asset. Furthermore, even if they are not worth anything at the present time, options often last for years into the future, thus they represent an opportunity to see significant gains with little or no cost to the employee spouse.
Always have your attorney closely examine stock option agreements and plan documents, even if they seem worthless at this time
Innocent Spouse Status
When you sign a joint tax return you are normally responsible for paying the tax and liable for any further assessments or audits. Oftentimes, a divorced spouse will find the IRS is pursuing them for tax obligations that they thought their spouse was responsible for.
Where a spouse who runs a business is audited, typically the other spouse is jointly responsible for any assessments. Congress has created various protections known as “innocent spouse status” for spouses who believe that the other spouse was hiding income or misstating facts on their return. These protections are discussed in more detail on theinnocent spouse article on this site.