In a perfect world, we would each get exactly what we are owed in a divorce.  In a perfect world, we would all stay happy, healthy and married.  Since we aren't living in a perfect world, it's no surprise that when two sides each feel they have claim to something, creative methods will be used to establish an advantage over one side of the negotiations.  

Whether these types of strategies are cunning or underhanded likely depends on which side of the negotiating table one sits.  So, it's best to be fully informed regarding tax liability, advantages or disadvantages in regard to one's settlement.

Know your tax basis of each asset/investment

Generally, it is the purchase price with expenses (improvements in regard to real property), plus dividend reinvestment, minus any commissions used to determine capital gains or losses.

When divorcing each spouse is given information regarding the tax basis of an asset when title or ownership of the asset changes.  The problem is that many spouses do not receive this information prior to the selection of said assets in order to adequately consider the value of each asset for the purpose of asset division.

Creative division

It's not uncommon for one spouse to have more knowledge of the couple's investment holdings and tax liability or carryover's.  If you are not the primary spouse who has managed the investments you should gather all details relevant to your assets immediately.  Both spouses should consult professionals, specifically a tax attorney or accountant regarding assets and investments in order to know the following: 

  • Know your current investments held by you and your spouse.
  • Understand how each is owned.
  • Know the legal and fair market value of each investment.
  • Know any penalties for early withdraw.
  • Understand the tax basis and value of each investment after tax and after sale?
  • Think about what assets you seek in the settlement and any tax liability or advantage of selling at a certain time or holding the investment for a planned period of time.

If you do not know the answers to these question before meeting with your tax expert, that's okay.  You should however, have all the records regarding these questions available to you and your tax expert so that he/she can properly advise and/or answer these questions to help you negotiate your settlement.  You may also need to meet with other legal, financial or real estate professionals to assist you.  

How can I owe more when we split our assets evenly?

There are various terms when seeking a divorce that can be confusing.  To be clear, in this article, when referencing an even distribution of assets, we are referring to an actual 50/50 split of all property obtained by the couple while married (most notable in community property states).  This means if the couple has $100 in assets, each would be given $50.  However, there are various types of investments and tax laws that can cause either spouse to have a tax disadvantage despite seemingly even division.  Furthermore, most states are equitable distribution states which means the division of assets is based on an equitable or fair division rather than an equal one.

  • Understand how your states law's may affect your settlement and know if you live in a "community property state" or "equitable distribution state"
  • Ask a legal expert how your state's laws would affect your case if litigated opposed to accepting a less than perfect settlement at the negotiating table
  • Ask a legal expert to advise you on how your prenup will affect your settlement
  • Understand the differences in trust funds and how you and/or your spouse's trust fund may affect your settlement
  • Based on the state your divorce is filed, ask a legal expert to explain how premarital assets may affect a judge's decision to divide marital assets unequally and seemingly inequitably if only considering marital assets (suggesting the possibility of an advantage of accepting a less than perfect out-of-court settlement)

There are numerous tax laws and means of analyzing investment value.  It can be difficult to determine the overall value of a couple's assets/worth, as well as, the value of each individual investment without knowing all the details relevant to each asset. 

Each investment can have different tax liability attached to it based on numerous factors.  This means not only could you be liable for more taxes despite the even split of market value of each asset, but consequently one spouse's settlement could be considerably more or less based on these certain liabilities or advantages of individual marital assets selected by each spouse in the settlement.

There are many factors involved: yield, total return, taxes, ownership, penalties, when it was purchased or attained, when it is planned to be sold, etc.  This is why it's important to consult with legal, tax and financial experts who can properly advise you regarding the value of each asset and potential gain or loss on the basis of your total settlement.  You may also need to attain appraisals to determine current fair market value of some investments.

What types of investments could have specific variables in value (to include but not limited to tax liability)?

Checking, savings, CD's, money market funds, mutual funds, personal notes, stocks, treasury bills, government bonds and municipal bonds, corporate bonds, EE U.S. savings bonds, zero coupon bonds, real property (to include family home), income producing property, REITS, vacant land, cash value life insurance, annuities, collectibles, leases, limited partnerships, general retirement accounts, IRA's, 401Ks, etc. 

The nature of each investment and corresponding previous tax returns will make a difference in determining tax basis and overall value when planning and negotiating the settlement.

Know what you want

Both spouses should have a general "wish list" and plan regarding how each spouse plans to maintain or sell investments to maximize the greatest potential in the division.  While legal, tax and investment issues are considered in this manner for the greatest potential settlement for each spouse, one will also have equal regard for his/her personal interest, such as: couple's home, living arrangements, insurance, employer based investments and self employment income from a jointly owned business.  This means it's complicated.

Even one asset can require careful consideration

While there may be reasons that are financially beneficial for specific settlement terms, it may not be suited to each spouse's personal situation.  For instance, financially it may be best to sell the family home so that each spouse can maximize the capital gains exclusion on the proceeds from the home based on relevant tax laws, but both spouses feel it is in the family's personal best interest for one spouse and the children to remain in the home and for both spouses to remain co-owners. 

Though there may be some tax loopholes to consider (in this example one would refer to a tax advisor or IRS regarding the Section 121 exclusion specific to  eligibility for exclusions of capital gains tax for the sale of a marital home), depending on how and when the home's ownership changes, one spouse may be disadvantaged on the basis of eligibility for the exclusions, market changes and asset's overall value when sold.   The overall settlement may need to be modified to offset the anticipated loss of the exclusion assumed based on selling the home in later years.  

There are numerous ways to balance this for a fair settlement to ensure the home is sold so that both parties qualify for the exclusion or through allocation of other marital assets and/or a cash payout at the time of the settlement.  A detailed clause in the divorce settlement regarding the home sale should be established. None of these details can be regarded in the overall settlement if either spouse does not have and understand the details regarding each asset.

Protect yourself for the best results

If both spouses are not aware of the tax laws and tax basis of each investment then one spouse could negotiate a less equitable settlement based on tax liability of equal valued investments.

It doesn't mean that tax basis advantages or disadvantages will not be part of the overall settlement and to one spouse's benefit or loss, but both spouses should be aware of either in order to make the most informed decision regarding the overall settlement and legal, financial, tax and emotional liabilities accordingly.

Each spouse should understand the following in order to make the best decision regarding tax implications and how they will affect either spouses settlement and the effect on their personal circumstances.

      • Know how each investment is owned (jointly, husband or wife)
      • Understand legal/equity value/tax basis (fair market value subtracting debt and used to determine capital gains or loss)
      • Understand financial gain (factoring in tax liability/early withdraw penalties/after sale value)
      • Determine plans to maintain or sell assets each spouse wants in the settlement (particularly regarding capital gains/loss/carryover and other tax liability or advantage)

Be very cautious of a spouse who wants to settle before allowing enough time to adequately determine value, understand tax liability and how each asset is valued. Sometimes certain personal advantages and emotional well being will supersede financial settlement disadvantages. This is a decision for either spouse to determine when and if he/she wishes to settle in this regard in order to avoid a long-term legal battle.  However, it's best to know the facts and values before making such decisions.

Settlements aren't perfect

There are numerous creative ways to determine a distribution that in later years may still result in one spouse having received a better portion of the overall marital assets based on inflation/loss, future market conditions and tax liability.  It may be impossible to ever come to an exact 50/50 division or fair distribution (depending on where and how your settlement was negotiated) when considering all factors of investment potential and tax implications.  Both spouses need to rely on having all details of investments available prior to negotiations along with trusted advisors who can help them determine the best settlement at the time of the divorce with considerations of future value and tax liability.

-OurDMK.com



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