For most, a divorce is a very emotion and stressful process. Amidst the monumental changes in your life, there are legal, residential and financial issues that need to be addressed. That’s why it is important to assemble a strong support team of professionals to assist you in making educated decisions and plans for your future. With so much to consider, working with a CPA can take some of the worry and burden away and allow you to focus on the most important aspects of this change in your life.
Why do you need to consult a CPA?
It is a wise – and common – choice to utilize legal counsel that is well versed in family law and divorce matters to assist you in navigating through this complicated process. With the many fiscal changes involved in the dissolution of marriage, it is important to have the professional guidance of a CPA. The appropriate professional can help you and your attorney to accurately assess and value assets, determine the tax implications of various settlement options, and guide you in financial and tax planning for the years that lie ahead.
While all of the following areas are important during the divorce process, each also has specific financial implications.
Property Settlement
While one spouse is usually happy to be awarded property in a settlement, the downside is that the “basis”, or the taxable value of the property, also comes with it. This means that he or she could owe income tax when the property is sold. As a result, when property is divided during the settlement process, this potential tax liability should be factored into the valuation of various assets.
Alimony
Alimony is deductible by the payer and taxable to the recipient. It must be paid in cash, and must be received by - or directly for the benefit of - the receiving spouse. Any portion of a payment that is specifically indicated as child support is not considered alimony, and therefore not deductible. Remember that it is important to consider the tax consequences to both spouses when determining the amount of a settlement considered alimony.
Child Support
Unlike alimony, child support payments made for minors are not deductible, but they are also not considered income to the spouse that receives them. Keep in mind that settlement payments that are not designated as child support can and will be reclassified as such if they are to be reduced by a certain event in the child’s life, (i.e., graduation, leaving home, etc.).
Tax Credits and Exemptions
Dependency Exemption: The parent granted custody of a child can take the dependency exemption for that child. A noncustodial parent can only claim a child as a dependent if the custodial parent signs a written statement granting the dependency exemption. Remember that exemptions are phased out for higher-income tax payers.
Tax Credits: The parent who maintains a home for the dependent child for more than half of the year may also qualify for the earned income credit, the child care credit and the head of household rate, even if he or she has agreed to sign the dependency exemption over to the other parent.
Medical Expense Deduction: Regardless of who has custody, or which parent receives the dependency exemption, the parent that pays the child’s medical expenses can claim them with his or her own.
Deductible Fees
The majority of professional fees directly related to a divorce are not deductible. Legal fees that relate to a property settlement, however, can be figured into the property’s “basis” (or value for tax purposes). Fees paid for obtaining alimony and tax advice in connection with the divorce (such as we would provide) are deductible as miscellaneous itemized deductions.
Sale of Residence
Compared to the past, the sale of a home relative to a divorce is much less complicated today. The majority of sales are not taxable – including profits up to $250,000 for individuals and $500,000 for couples who owned the home and occupied it as their principal residence for at least two of the five years prior to the sale.
Retirement Accounts
Assets saved in retirement accounts should not be overlooked during a divorce settlement, however they can be extremely complicated to divide. If not handled properly, consequences can be severe and unpleasant tax penalties can arise. We highly recommend consulting a financial professional when dealing with this type of asset.
Wills and Estate Planning
A radical change in family status, such as a divorce, is cause to revise your will, estate plan and financial plan as soon as possible. In addition to the obvious need to change beneficiaries, your estate’s tax assessment can be impacted by the process.
The Tax and Financial Issues Involved in a Divorce