While we are enjoying the holidays with our families, let’s keep in mind that there are many who are struggling in difficult marriages and may soon undertake divorce.
For those families we offer our prayers.
Today is the fourth in a four part series on federal tax issues that may arise in a divorce proceeding. The first week we addressed the high rate of divorce in our society, the need to set aside emotional hostility and focus on resolving issues to minimize damage to the family, and the possibility of innocent spouse treatment and how it may affect the divorce decree. Then we addressed several tax issues, including how to avoid carrying taxes into a later marriage.
Here are some additional tax issues to consider:
- Basis
Some couples are fortunate to have accumulated wealth during the marriage, often either through their own hard efforts, inheritance or gifts from family members, commingling of separate property, etc. When they get divorced they have to divide these assets among themselves. For most people this appears at first glance to be fairly simple in that they just consider the value of those assets and divide them accordingly.
However, from a tax point of view, the basis of those assets can be very important. There can be a hidden tax issue there.
Basis is essentially the cost of those assets reduced by any depreciation. Once the asset is sold or otherwise disposed of, we have to report income tax gain on the appreciation- the sale price over that basis. Thus, a couple may make an equitable division of assets but because of the difference in basis one party may have a big tax bite once those assets are sold. This may be magnified even further if the gain on the sale of one asset is not taxed- such as on the sale of a house.
For example , one party may get the home and the other spouse gets rental property. The home sale may generate a large gain that is not taxed under the tax law while the sale of the low basis rental property generates a large taxable gain.
I’m suggesting to you that in a divorce setting the tax basis of the assets acquired during the marriage should be an important consideration in the division of the assets .
- Life Insurance
In many divorce decrees, one of the divorcing spouses may be required to continue to maintain life insurance and medical insurance for the benefit of the ex-spouse or for the benefit of the children. Life insurance is a difficult matter to consider because of its complexity. The decree can arrange for the insurance premiums to be deductible alimony depending on who the owner and beneficiary is. The life insurance can also generate estate taxes depending on who the owner and life insurance beneficiary is (the person to pay those taxes needs to be identified). I don’t want to say any more about this because of its complexity other than careful consideration needs to be given to this issue as well.
It has been my experience over the last 38 years of law practice that most divorces end up sooner or later being a bitter and angry affair and financial and tax issues that were not properly considered beforehand for inclusion in the divorce decree can inflame that hostility into something even more ugly.
Folks, I encourage you to get a good family lawyer to represent you in the divorce, and also to specifically ask him or her to consider some of the items I’ve described over the last four articles so that you can be adequately prepared and that there are fewer surprises down the road.