Wednesday, August 28, 2019

Four Hidden Costs of Divorce - From a Divorce Lawyer

As someone going through divorce, when a divorce lawyer contacted me asking if she could write a post talking about the hidden costs of divorce, I was very intrigued. Here's what Katherine K. Wagner, Esq has to say on the subject. I must say, I certainly learned a lot!

For most couples, legal and filing fees are only the beginning of the costs of divorce, and I am only talking about actual costs, not emotional cost.

To be forewarned is to be forearmed. I’m writing this article to forewarn you of possible costs of divorce that you have not yet considered so that you and your attorney can plan accordingly. There are four main areas of concern.

1. Alimony vs Child Support

Although alimony and child support are both forms of financial support for a broken family, the IRS treats them very differently. This may impact what forms of support you negotiate for during the divorce.

The Tax Ramifications of Child Support

The IRS considers child support “tax neutral.” The custodial parent receiving child support payments does not report those payments as income. The obligor parent does not deduct child support payments paid from taxable income.

The Tax Ramifications of Alimony

Prior to January 1, 2019, alimony was treated differently. The obligor parent could deduct alimony payments from taxable income and the recipient of alimony had to report the alimony payments as income. A caveat: if “alimony” is received as something other than cash, such as property, then the IRS does not consider it alimony. With the tax code changes taking effect at the beginning of 2019, alimony payments are now no longer deductible from taxable income of the obligor, nor are they taxable to the recipient. However, modifications of the alimony amount, either up or down, after January 1, 2019, for alimony agreements made before that date still maintain their tax-deductibility and taxability.

2. Dividing Marital Assets

How you divide marital assets will have financial repercussions, both positive and negative. Plan ahead to achieve the best outcome
Tax Treatments of Different Financial Accounts

First, different types of accounts have different tax treatments. Let’s say a retirement account and a bank or investment account are each worth $150,000. On their face, they have equal value so you may be tempted to think that they can be divided equally. However, you should know that withdrawals from the retirement account will be subject to an automatic 10% tax penalty and then be taxed at your ordinary tax rate, while withdrawals from the bank account may have no tax consequences or will be taxed at (typically) lower capital gains rates if it is an investment account – and then, only the profits are taxed.

You and your spouse will have to disclose all accounts of any type in the process of divorcing. With the account information of your spouse in hand, plan accordingly.

Tax Brackets and Your IRA

Second, you should know that it is fairly common for income to drop following a divorce. Such a drop is inevitably followed by a drop in the tax bracket. This may provide a spouse with a traditional IRA the opportunity to save on a Roth IRA conversion. Please check with your tax professional about the feasibility of such a conversion.

The Marital Home is Under Water

Third, if the marital home has decreased in value over time, this can complicate even the most amicable split. Short selling is an option, but selling your house for less than you owe will wreck your credit. Also, if your mortgage lender forgives the remaining balance, that amount is taxable as income.

The Marital Home has Equity

Last, the timing of when you sell the marital home will impact the amount of return you will receive. A married couple can exclude up to $500,000 from the sale of their home on their federal tax returns. If the property is instead transferred to one spouse and sold after the divorce, that tax exclusion drops to $250,000. In this case, you might consider selling the house and dividing the proceeds before filing divorce.

Remember also that selling a home will entail paying realtor’s fees, as much as 6% of the selling price.

3. How Long Were You Married?

This is highly state-specific, however, in general, a marriage that lasts beyond 10 years may entitle an ex-spouse for spousal Social Security benefits and, depending on the state, extended alimony.

If one spouse is in the military, a 10-year or more marriage may entitle the ex-spouse to military benefits and a portion of his or her pension.

A divorced spouse can file for spousal Social Security benefits regardless of when the ex-spouse files, under certain conditions such as the duration of the marriage, the recency of the divorce, the ex-spouse’s age, and the ex-spouse’s Social Security eligibility.

4. Being Single is More Expensive than Being Married.

Be prepared, because this is the truth.

First, when you get divorced you both lose the tax break you get as a married couple filing jointly. Perhaps, if it is close to the end of the year, you might wait to get divorced until the new year.

Second, married couples share one household, generally. Once you are divorced, you each must maintain your own household. This will take more time and more money from you both.

About the Author

Katherine K. Wagner, Esq . graduated from Duke University and Washington & Lee University Law School. Ms. Wagner also holds a Certificate in Divorce Mediation from Rutgers University, and is a graduate of the American Bar Association Family Law Advocacy Institute.

See my disclaimer.