Tax Consequences to Consider During Property and Debt Division

Division of assets and debts may sound easy, but it is often not. Read on about the tax consequences of property and debt division in divorce.

retirement plan and divorce

As a divorce attorney or family law attorney, it is sometimes interesting to hear what people think you actually do.  For instance, someone once said to me, I don’t see what’s so difficult about what you guys do. All you do is divide everything in half.”  If this were the case, we wouldn’t need to discuss tax consequences.

Division of assets and debts may sound easy, but it is not often easy at all. I remember seeing a movie once where something (illegal) was going to be divided in half. One of the two people in the scene said, “I’ll divide it in half.” The other person responded, “That’s fine. You divide it in half and then I’ll pick which half I want.” The concept of “Divide and Choose” has received a lot of attention historically. Look up “Divide and Choose” in Wikipedia for some interesting history on division of things into “halves.” Also look at other articles and commentaries on the Internet on this subject.

So. . . if we are dividing a “thing” such as a piece of paper, division may not be so difficult (so long as each part of the paper is the same as all other parts of the paper. In divorces and dissolutions, however, some assets and debts may be easily and fairly divisible (with each party receiving the same benefit or taking on the same type of obligation as the other party after division) while other assets and debts may not be the same.

Tax Consequences to Consider During Property and Debt Division

The Difference Between Dividing Pre-Tax and Post-Tax Assets

In divorces and dissolutions, one must always watch for tax consequences. By way of example, let’s think about a marital bank account. If a marital bank account has $100 in it from a few years ago and the taxes have been paid on all earnings from the year in which the $100 was earned, this $100 is “after-tax” money. It is cash that is available “in hand,” which can be spent. Division of that bank account, with each spouse getting half—or $50 eachleads to the same result for each of the people in the divorce or dissolution since they are just being given half of what is already their property. Good enough so far. Receiving your own property in a divorce, or half of the marital property in a divorce, does not create a taxable event. However, spending it may create a taxable event later, and not all taxable events will be equal for both former spouses.

What if a marital bank account has $100 in it and half of that would be owed to the other spouse but the other spouse has a marital Traditional IRA which also contains $100. Couldn’t we just let the one spouse keep the $100 IRA and the other keep the $100 bank account to make them equal on property distribution? The answer is, “No.” This is because when the spouse who keeps the Traditional IRA finally starts taking out money, that money will be taxed. At a 30% tax rate, that $100 Traditional IRA will only be worth $70 after taxes. The $100 in the bank account will still be worth $100 even after the $100 is taken out. It is “post-tax” money. You don’t get charged anything, tax-wise, to remove your own money from your own bank account. In the example above, in the end, one former spouse has $100 and the other only has $70.

What Happens to Investments and Debts

The same principle (involving the possible effect of taxation on different types of assets) will also apply to stocks and other investments. Tax on proceeds from the sale of investments may be calculated upon how long the investment has been held and also upon the actual gain on sale (gain over the original cost of the investment). So, the “market value” of 3,000 shares of one stock which has a value of $1.00 per share ($3,000) may be the same “market value” as 3,000 shares of another stock which has a value of $1.00 per share ($3,000), but the after-tax effects of selling those shares and collecting their value may be greatly affected by taxes on the gains (depending on the original costs of the shares and how long they have been held, etc.).

The same type of principles can be applied to debts of differing kinds, which might be assigned to the parties to a divorce or dissolution. A debt given to one spouse may be of “more value” to him or her than if it were given to the other spouse.

The Importance of Working with a Financial Expert During Your Divorce

The “moral” here or the “warning” here is: Hopefully, we aren’t just dividing things in half. Hopefully, we are only dividing after considering the tax effects and status of each asset and debt with which we are dealing.” Our firm is proud to have relationships with many excellent and respected financial experts, CPA’s, business valuation experts, and other types of experts. We take advantage of these relationships to involve those experts in our clients’ cases to help advise our clients regarding the tax consequences and other financial aspects of their marital termination.

William Geary is a family lawyer who has been practicing since 1979. He is admitted to practice before the Supreme Court of the United States, and also is a practicing member of the Ohio bar.

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