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How can you avoid tax pitfalls during divorce?

On Behalf of | Nov 6, 2020 | high asset divorce |

Thinking of what is fair in a divorce can seem daunting, especially when it involves property division and custody. Michigan is an equitable division state, which means that property is not divided 50/50, but it is distributed fairly according to the judge.

Factors that a judge takes into account include whether or not one spouse has the larger income and is able to give more, if one spouse was responsible for most of the debt, or whether or not one spouse is more to blame for ending the marriage.

Be careful of cash valuations of assets

During a divorce, everything is given a monetary value that has been acquired during the marriage, including the house, accounts, stocks, bonds and business interests. There are a few potential pitfalls to avoid that have major tax implications when adding everything up.

First, when dividing assets, it’s a good idea to think of the actual cash value of the property that is divided. For example, if the couple spits two IRA’s, one a traditional and the other a Roth, one spouse will definitely come out ahead. The cash in the traditional IRA has never been taxed, so when it comes time to withdraw funds, the taxes on it may be up to 35%. The Roth, on the other hand, does not have these tax issues.

Not all stocks are created equal, either. Two holdings of the same stock valued equally will be taxed on capital gains differently depending on how much the stock appreciated when it comes time to sell it.

Tax credits and liabilities

Even though the recent tax law zeroed out the dependency exemption that parents can claim through 2025, there may be other tax benefits for the custodial parent in a divorce. If this parent’s income falls within a qualifying bracket, they may be eligible for child-care, educational, earned income and child-tax credits.

It is important to account for tax liabilities or credits that are part of the property division in the divorce settlement. If you know that you have a tax refund coming due to underperforming business or stocks losses, these “loss carry forwards” from previous years can offset current or future taxable income.

By that same token, if the divorcing couple is filing joint returns and owes taxes, the IRS may go after you even after the divorce is finalized. To avoid this, it may be best to file as married filing separately, or draw up a tax indemnification agreement for protection.

Getting professional advice on dealing with complex financial issues is perhaps the most important consideration you can make to protect your financial future after divorce.