Saving Taxes

It could quite literally cost you tens of thousands of dollars in additional taxes if they are not properly addressed. This is especially true when dividing retirement plans during divorce. For example, employee benefit or pension plans subject to ERISA (401K, 403B, defined benefit, etc.) require a Qualified Domestic Relations Order (QDRO) in order to transfer the money from one spouse to another spouse’s retirement without incurring income taxes or the 10% early distribution penalty.

There are also the missed tax savings by not properly structuring a tax plan that maximizes these savings. A proper plan can be designed only after running tax projections taking into account multiple factors to optimize the tax savings. It is critical that planning is pro-active and not re-active. Once the tax year is over, it is difficult to implement some of the necessary strategies. It is also important to note that the IRS does not rely on the information in the divorce decree, since a state court cannot determine a federal deduction. They have their own regulations that need to be satisfied.

Whenever possible, assets and debts should be divided on an after-tax basis. Consider the following example:

Jack and Jill are in their mid-fifties and have been married for 30 years. Their children are grown and they are still living in the marital residence they purchased 25 years ago for $150,000. They have decided to divorce and are trying to amicably divide their assets. Jill would like to keep the marital home as this is where she raised her family. Jack would like to retain his 401k plan as he worked very hard at his company. They also have an investment property that they purchased 15 years ago which Jack thought he could live in for a year before selling it. Jack and Jill also had some stock, cash and CDs.
They agreed to divide these assets in the following manner:

They both thought this sounded fair, but they forgot to take into account the tax ramifications of selling the assets. After meeting with a divorce tax planner, they revealed the following details:

1. The marital residence was purchased 25 years ago for $150,000 and $50,000 was spent on an addition 15 years ago. Although the house was valued at $400,000, there was no mortgage on the property and the capital gain upon sale would be $200,000 ($400,000 minus $150,000 purchase price minus $50,000 improvements). This is less than the $250,000 Section 121 allowance on sale of personal residence, so no tax would be due upon sale.

2. The investment property was purchased 15 years ago for $100,000. It has $50,000 of depreciation which needs to been recaptured and taxed upon sale, as well as, tax on the capital gain of $150,000.

3. Jack will need to pay ordinary income taxes on the 401k distributions upon retirement.

4. Jack will have a $50,000 capital gain upon the sale of his stock.

A more accurate after tax value revealed the following information:

* For simplification purposes real estate sale expenses were not included in calculation

By reducing your tax liability, you are increasing the amount of cash you have available. Your Accountant-Mediator will recommend making adjustments to your Form W-4, so you can realize this tax savings in your net paycheck instead of waiting until you file your tax returns.

According to the CCH Standard Federal Tax Reporter, as of 2013 it takes 73,954 regular 8-1/2 x 11 sheets of paper to explain the complexity of the U.S. federal tax code! This does not include state or local taxes. Divorce brings its own set of nuances that many accountants may find unfamiliar. In addition, most accountants are compliance oriented and work with historical or present-day scenarios. They are not accustomed to projecting into the future as is required in divorce tax planning. Some of the questions your accountant would need to address are:

• What is the best qualifying filing status?
• Who should claim the dependents to minimize the overall tax liability?
• Are deductions and credits being lost to income phase-out?
• How does one release the dependency exemption to the non-custodial parent?
• Who is able to use any tax carryforwards?
• Which assets are more tax advantageous when dividing the marital estate?
• Do we have to pay taxes when we sell our home or other real estate?
• How will alimony payments or child support change my taxes?
• How do we properly divided retirement plans?
• Do we need to adjust our Form W-4 withholdings with our employers?
• How can we be sure you are acting in both our best interests, neutrally?

You can rest assured that our Accountant-Mediators are very experienced in the intricacies of tax planning when it comes to separation and divorce. We do neutral mediation, so both spouses are put on equal footing and we’ll maximize the best outcome for each of you.