Divorce is a scary time for all involved – so many emotions, so many unknowns. For most folks, it can be the single largest financial event of their life. So how can you prepare for the divorce process from a financial standpoint? While no one can ever truly prepare for the emotional ride, there are a few tips that can assist in making the financial journey more efficient and less time-consuming, ultimately allowing both parties to get back to their lives sooner, with fewer dollars spent on legal fees:
1. Estimating Future Living Expenses – In many cases, a single source of income that previously supported one household must now support two households immediately after the divorce. It’s important for both spouses to project future living expenses to assist the attorneys and financial professionals in the process. Some use the term budget, but that term can be unclear as to whether it’s referring to historical or future expenses. The purpose of this exercise is to estimate future living expenses to help with potential child support and spousal support (alimony) decisions. Tennessee is a needs and ability to pay state, so it’s important for the receiver of alimony to demonstrate his/her need while the payer must demonstrate his/her ability to pay.
2. Identification of all Joint Bank Accounts/Credit Card Accounts – Both spouses should compile a list of all bank accounts and credit card accounts, as well as the name(s) on those accounts. During the process and post-divorce, it may become necessary to close out all the jointly-held accounts and cards and require each spouse to open new accounts and credit cards.
3. Asset/Liability Statement – Couples should compile a list of all assets and liabilities owned/owed during the marriage, along with any separate assets and liabilities. This information will assist the attorneys and financial professionals in property division decisions. Couples who have recently submitted a personal financial statement to a bank or lending institution may utilize that information for this purpose also. Often a tax return is a great road map in starting this list, as it will include pertinent information on assets and liabilities.
4. Insurance Policies and Beneficiary Information – Couples should compile a list of all insurance policies including terms, benefit and beneficiaries. Often insurance policies are used as collateral for child support and/or spousal support payments. Beneficiaries may be updated or carved out on larger/existing policies to satisfy collateral in the divorce process.
5. Taxes – In the asset division tug of war, tax returns are often not reviewed/considered. There are numerous decisions to be made in the tax arena to prevent future confusion and mistakes. Below are a few key areas for consideration.
- Tax filing status is determined by marital status on the last calendar day of the year. In other words, if you are married on December 31, then you file taxes as married. Many filing changes are triggered the first year after divorce. For instance, the tax filing status will likely change to either single or head of household. Spouses will want to review the factors that qualify for head of household, including the number of days each spouse will have the children according to the parenting plan. Only one spouse can claim head of household for one particular child. If there are multiple children, it is possible that both spouses meet head of household.
- While the new Tax Cuts and Jobs Act suspends dependency exemptions (beginning in 2018), child tax credits remain and they will certainly continue to be a key negotiating factor in divorce. The credit has increased to $2,000 per qualifying child, and new for 2018, the credit is now partially refundable.
- Due to income phase out levels that can reduce/eliminate the tax savings associated with these credits, it is important for both spouses to consult with a CPA and be aware of these thresholds. Typically, there is one party who will receive more benefit due to these restrictions.
- Mortgage, charitable and interest expenses (just to name a few) should often be allocated between spouses in the year after divorce. While the logical allocation is based upon who paid the expense, joint marital accounts are often funding these costs, so discussion around which party takes which expense is very important. Relying on tax documents that often issue to only one social security number may not present the true economic effect of these costs. Both parties need to discuss an equitable division of these costs during the divorce proceedings, as it will certainly trigger tax notices if mistakes are made and both parties claim the full deduction.
- Charitable, Capital Loss and Business Loss Carryovers are hidden assets on the tax return. Just as the assets that created these tax losses are divided in the divorce proceedings, it is equally important to address who owns these carryovers and who will receive benefit when the carryovers can be utilized.
- It is better to discuss these tax items early in the first year or during the divorce process to ensure there are no surprises or negative consequences to either party when it is time to pay Uncle Sam.
6. Credit Reports – Both spouses should monitor their respective credit reports during and after the divorce process. With numerous accounts/credit cards being closed and opened, spouses will need to verify their credit reports are accurate and that they aren’t reflecting liabilities for which they will not be responsible going forward. Monitoring credit reports is also a great way to discover accounts that you may have forgotten exist.
7. Financial Relationships – In particular, a non-business spouse might want to interview accountants and other financial professionals during the divorce process. Those financial professionals not only can assist the spouse with the items on this list, but can also serve as new financial relationships that a non-business spouse will almost certainly want to form post-divorce.
LBMC has both tax professionals and business valuation/litigation support professionals to assist in the key areas mentioned above. We are happy to help you navigate the choppy waters of divorce by providing some peace of mind in the financial arena.
With statistics still showing that close to 50% of marriages end in divorce, it is crucial to have your financial ducks in a row prior to the negotiation process. This article gives you seven areas of focus to help you be most prepared for the journey ahead. Taking steps now to become organized in financial matters will save time and dollars later.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.