A divorce can be a complicated process. All too often, clients are focused on getting “more” out of the divorce than their spouse. This can cloud judgment and make it difficult to achieve a successful and meaningful resolution in a divorce. It is important to talk with clients about the tax and financial consequences of a divorce. Clients should be aware of how “getting more” in the divorce could ultimately be problematic. As family law and divorce lawyers, it is our responsibility to make sure that clients approach divorce discussions with as much information as possible.
Taxes aren’t the most exciting topic of discussion.
However, tax implications are inherently intertwined in a divorce proceeding. Spouses who get divorced will have to adjust how they file their taxes, what income and liabilities they must report for tax purposes, and even how they approach discussions about alimony and spousal support.
Clients will often be guided and driven by emotion. It is important to insert some objective considerations into the equation.
The Ability to Claim Dependents
Spouses will likely have to change their tax return filing status in the future. This, of course, will depend on whether the spouses remarry right away and if parents retain the right to claim any children as dependents. The ability to claim dependents on a tax return can be incredibly beneficial. It can allow for additional deductions and credits and can significantly reduce a parent’s tax liability. In some cases, parents can qualify for refunds that may have otherwise been out of the question.
If your client would not necessarily benefit from claiming his/her child on a future income tax return—perhaps because they have a high income or can claim other children from a previous relationship—they may be able to use the deduction as a bargaining chip. While your client may not want to give up the deduction for personal reasons, it may be beneficial to offer future deductions in exchange for receiving another benefit in the divorce. Spouses who understand the underlying financial implications of their decisions may be more likely to approach divorce settlement negotiations with an open mind.
Taxation and Future Financial Consequences of Marital Assets
The way in which property is distributed in a divorce often depends on the state in which the couple resides and whether or not there is a prenuptial agreement. Spouses who want to get divorced should consider how these factors will impact their ability to divide their marital assets.
All but nine states use equitable distribution laws. When a divorce is contested in these states, the court will step in and determine how property should be divided. This allocation will not necessarily be equal. Rather, it will be equitable. The court will consider what is fair and reasonable after considering a number of relevant factors. Spouses who divorce inequitable distribution states could potentially be awarded all of the marital property, none of the marital property, or any percentage in between. When spouses divorce in community property states, each is entitled to half of the community marital property. This division is equal rather than equitable.
Spouses who anticipate that a divorce may not be amicable and want to maintain some control over the division of property can execute a prenuptial agreement. In a prenuptial agreement, spouses pre-determine how property, assets, debts, and liabilities will be divided in a divorce. This can be general (“each spouse shall receive 50 percent of the marital assets and liabilities) or specific (“Spouse A shall get the house; Spouse B shall get the car”). Spouses who execute prenuptial agreements often take the tax consequences of distribution into consideration. It may be wise to discuss a prenuptial agreement with clients who are thinking about getting married or a postnuptial agreement with spouses who are already married.
Spouses who refuse to come to a mutually-agreeable resolution to property division risk leaving important decisions to the court. While most property transfers in a divorce are not taxable, the property that each spouse receives may have its own unique tax consequences. For example, if your client wants to get everything in a divorce and leave his/her spouse with nothing, they must realize that they will be on the hook for payments related to any property they receive. If your client wants the house, it is important to emphasize that he/she will be responsible for property taxes, mortgage payments, and other home-related costs. If your client wants everything, they must also know that they will be responsible for resulting taxes, fees, and expenses as well. Getting “more” can come with a hefty price tag down the line. Since most divorce-related transfers are not taxable, now may be the time to discuss what is best for both spouses in the future, rather than what will be self-satisfying in the moment.
Alimony and Spousal Support
Alimony is generally both included in the recipient spouse’s income and a deductible expense for the payor spouse. Even the discussion of alimony can trigger tense emotions and distress in a divorce. However, it is important to understand the tax implications of alimony and spousal support. These can help to guide conversations and establish appropriate payments. Spouses who will be required to pay alimony may want to establish higher alimony payments in exchange for receiving less marital property. This would allow the spouse the best tax position. The spouse who is entitled to receive alimony may want to receive less in alimony and more in marital assets. Marital assets may not have immediate tax consequences, whereas alimony will have to be included as income. Spouses can use alimony as a device to negotiate the division of property and allocation of dependents.
There are many issues that should be taken into consideration when approaching the division of assets, child custody, and alimony in a divorce. Spouses should understand the tax and financial consequences of any decisions they make in a divorce. These decisions should not be guided by emotion, but rather logical thought and foresight.
Steven Fernandez is an attorney and founder of Fernandez & Karney, a Los Angeles family law firm. Mr. Fernandez is a graduate of University of California – Los Angeles School of Law, is a California certified family law specialist, and has over 27 years’ experience exclusively handling family law matters.