How can you assist your client and the client’s attorney in realizing a fair and equitable divorce settlement? Here are several critical tax and financial planning issues:
Consider the benefits of a qualified domestic relations order (QDRO). If your client must distribute all or a portion of his or her retirement account to a former spouse, pay attention to the tax benefits of a QDRO (see IRC § 414(p)). Section 402(e)(1)(A) provides for the income tax to be assessed to the alternate payee (that is, the former spouse) and not to the plan participant when payments are made under a QDRO.
If a principal residence is part of the matrimonial estate, review section 121(d)(3). You may save on capital gain on the sale of the residence. When calculating use of the residence for purposes of the exclusion of gain from the sale of a principal residence, the deemed-use provision provides that “an individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument.”
Review current and prior tax filings for loss carryovers. The tax savings constitute marital property and should be properly quantified by the CPA.
Beware of alimony recapture. Review the alimony decree to avoid the potentially devastating consequences for the payor under section 71(f) of excessively front-loading alimony payments. IRS Publication 504, Divorced or Separated Individuals, provides an illustration of excess alimony payments and the resulting recapture of payor deductions. Also, for payments to qualify as alimony under section 71(b)(1)(D), there can be no liability for payments after the payee spouse’s death.
Insure the alimony payments. Insure the payor spouse, since alimony payments otherwise will cease upon that person’s death or may cease upon disability.
Evaluate any innocent spouse claim. In certain situations a spouse or former spouse can be relieved of tax, interest and penalties on a joint tax return under section 6015 (see “Innocent Spouse Relief: Alternatives After the Lantz Case,” JofA, Dec. 2010, page 46).
Plan for Social Security benefits. A divorced spouse can receive benefits on an ex-spouse’s Social Security record if the marriage lasted at least 10 years. The beneficiary spouse must be 62 or older and unmarried. Payments the beneficiary receives have no effect on the benefits the wage earner or that ex-spouse’s current spouse can receive. Also, if the wage earner and ex-spouse have been divorced for at least two years and both are at least 62, the ex-spouse can get benefits even if the wage earner is not retired.
Plan for payment of unsecured debt. While a divorce decree often stipulates who is responsible for the couple’s unsecured debt, the decree does not bind creditors. Consequently, if the obligated spouse does not make payments or makes them late, this will negatively impact the other spouse’s credit. A remedy would be to satisfy all unsecured debt with matrimonial assets or have the nonobligated spouse make the payments and increase alimony or maintenance accordingly.
Obtain a valuation of closely held businesses. A valuation specialist should be recommended to the client and the client’s attorney. A forensic accountant should be considered if there is a need to quantify lifestyle calculations or uncover hidden or disguised fringe benefits, pension benefits or other benefits.
Update estate documents. Assets may pass to unintended beneficiaries if wills, deeds, insurance policies and retirement plan documents are not revised where necessary.
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