by: Antonio Fricano
The truth is, most family law lawyers don’t have a firm grasp on the tax consequences of divorce. One reason we went to law school instead of to medical school was because we didn’t want to take the extra math classes. Instead, hoping to leverage our talents for writing, negotiating and public speaking we decided to enter into one of the most litigation intensive specialties within the law.
Still, these lawyers can provide effective representation for their clients. The reason is that most opposing attorneys are of the same mindset. This mindset is; “I am a family law attorney and if my client needs tax advice they should seek the advice of a tax professional.” This is good advice, but seldom clients actually abide by it.
The tax consequences of a divorce can have a tremendous impact on the actual (as opposed to stated) value each side receives in a property division or support order. This leaves those lawyers with an understanding of tax law in a superior bargaining position. The following article will discuss a couple areas where family law and tax law intersect.
The bargaining chips here are the exemptions and filing status. Exemptions are a tax deduction so they are a benefit for the spouse receiving them. Two ground rules to keep in mind is that a custody split should never be 50/50, (because neither party will get the exemption) and the court can’t order parties to take a particular filing status.
The advantages of taking certain tax positions can be analyzed by the DissoMaster software. Once the exact benefits to both sides are calculated, the negotiating begins. Generally, the tax deductions should be negotiated towards allocating them to the higher earning spouse. In that way both spouses collectively pay fewer taxes. Another result is that the higher wage earning spouse has a higher net income which will result in a larger order of support to the receiving spouse. All of this is, of course, is negotiable and can even be conditioned on certain events. For example, an agreement might have a provision that Wife sign the IRS form allocating the exemption to husband by January 15th each year, provided that she receive increased spousal support of a certain amount. These tax aspects can have a major impact on a client’s future finances and should be a point of negotiation.
This is an area where a basic understanding of tax law is crucial to obtaining a fair result for the client. Family law courts have two fundamental rules here:
1)The court does not take tax consequences into account when determining value
a.Example: If you are awarded the family residence and plan on selling it after the divorce, the court will not reduce the value it puts on the house just because you will have to pay taxes on the gain from the residence
2)Pursuant to IRC 1041, property transfers subject to a divorce are not taxed
a.Example: If you sell your interest in the family home to your spouse, you will not be taxed
California community property law states that each spouse shall get an equal share of the community property. This can be more complex than it seems. As an example, let’s say that we are awarding stock to Wife with a fair market value of $200,000 and we are awarding husband cash from the community bank account equaling $200,000. While this might seem equal, it probably is not. The stocks are subject to taxes, either a loss or a gain. If Wife has to pay taxes on $100,000 of the stocks when she sells them, she has gotten the short end of the stick.
Calculating Loss or Gain
The loss or gain for tax purposes on any property is equal to the selling price minus the basis. Basis is the purchase price of the asset, plus improvements, plus fix up costs, minus depreciation and deferrals. Obviously it can get complicated trying to figure out all these factors, so attorneys need their clients to take an active role in providing this information.
The situation gets even more complex when dealing with pensions. Pensions have early withdrawal penalties and other serious tax implications for divisions.
Also, a loss or gain may be avoided entirely with some estate planning. For example; if the spouse was awarded the residence and lived in the residence until his or her death, then the basis for whomever he or she willed it to, would be the fair market value at the time of the transfer.
How can you split everything equally when you are comparing apples and oranges? One way would be to take the King Solomon approach and divide everything in half, giving each side half an orange and half an apple. Sell the house and divide the proceeds. Each spouse takes half the stocks. If the pension or IRAs are unequal, roll some over from wife’s IRA to husband’s IRA or vice versa to make them of equal value.
However, the best course of action for clients is to hire an attorney that has a basic understanding of the tax implications of divorce. Clients can test prospective attorneys in this regard with a few preliminary questions during the initial consultation. An attorney with this basic understanding can save clients lots of headaches down the road.
Copyright (c) 2007 Antonio Fricano
About The Author
Antonio J. Friacno
c/o Law Offices of Donald P. Schweitzer
201 South Lake Avenue
Pasadena, California, 91101