Freedom Tax Planning

Your tax filing status depends on your marital status on the last day of the tax year. If you are unmarried, your filing status is single or head of household. If you are married, your filing status is either married filing a joint return or married filing a separate return. You must also follow your state law to determine whether you are considered divorced or legally separated. While you were not living together the last few days of the year, as long as you were still married you have the option to file married filing jointly.

Your marital status for tax filing depends on your marital status and your family status as of December 31. If you are divorced as of December 31, you must file as single taxpayers for that year, even if you and your spouse lived together as a married couple more than half the year. If you’re still married as of December 31, here's how it works:

If you and your spouse lived in the same household and were not legally separated, you must file as married (either a joint return or separate returns).

You may be able to file as Head of Household even if you were legally married on December 31. To file as Head of Household, you must meet all these tests:

You were unmarried or considered unmarried on December 31.
You paid more than half the cost of keeping up a home for the year.
A child or other qualifying person lived with you in the home for more than half the year for whom you or the other parent is entitled to claim the tax exemption.
You are considered unmarried if you were legally separated on December 31 or if your spouse did not live in your home for the last six months of the year.

Nearly all divorcing couples are aware of the exemptions for the children, and it's typical for each spouse to believe that he or she is entitled to them. The IRS assumes that the spouse who has custody of the children is entitled to the exemptions, but the spouses are allowed to trade them back and forth freely, using IRS Form 8332. With the passage of the Tax Reform Act of 1997, the exemption now carries with it the right to use the child credit for each child, as well as to use the Hope Scholarship and Lifetime Learning Credit

When there are multiple children, one option often used -- usually the wrong one -- is for the spouses to split the exemptions. This may feel fair to both spouses, but the spouses are never better off to share the exemptions, and if one spouse's income is substantially higher than the other's, the spouses will be worse off, because they will have missed a chance to maximize tax savings.

The better approach with exemptions is to consult an expert on tax in divorce who can calculate the value of the exemption(s) to each spouse. The one who can make better use of the exemption(s) should take all of them, and if appropriate, compensate the other spouse.

Alimony is included in the taxable income of the recipient, and it's tax-deductible for the person who is paying it.

Child Support is not included in the taxable income of the recipient, and it's not tax-deductible for the person who is paying it.

In order to determine whether you will have a tax liability when the marital home is sold, you should familiarize yourself with the IRS tax rules on the sale of a home. Currently, the IRS allows married couples to exclude up to $500,000 of the gain and individuals to exclude $250,000 from their taxable income. In order to qualify for this exclusion, your home must be your primary residence and you must have owned and occupied your primary residence for at least two of the last five years prior to the sale. To figure the gain on the sale of your home you will need to know your basis. For most people, it is the original amount you paid for your home. However, if you have made any improvements or taken any deductions then you will need to calculate your adjusted basis. For example, if the original cost of your home was $200,000 and you added a $10,000 pool, your adjusted basis becomes $210,000. If you then took an $8,000 loss for a flood, your adjusted basis becomes $202,000. To calculate your profit or loss, you should subtract the adjusted basis from the selling price of the home. If the number is positive, you have a gain. If the number is negative you have incurred a loss. Your taxable gain is determined by subtracting the maximum allowable exclusion from any profits.

Maintaining the marital home vs. selling it is one of the “top ten” mistakes most couples make when divorcing. The key thing to keep in mind here is the house does not pay your bills. You should be intimately aware of the financial consequences of keeping the home should this be an option to you. While you may end up receiving support in the form of child support and alimony, this amount may be far less than what you would need to maintain the home, as well as pay for the rest of your living expenses and raise your five children. Click here to read more (link to article)

It is very common for women to have an emotional attachment to the family’s home. Consider whether you will be able to cover your mortgage obligation and the other expenses associated with maintaining a home on your own. While refinancing may seem an easy way to eliminate debt, it may not be in your best interest. Before you initiate a refinancing and/or quit claim deed on your property, be sure you understand what you are getting into financially. How much equity will be left in your home if you pay off your debt and refinance the loan? Will you have enough money to pay your new mortgage obligation and other related home expenses? Do you have the ability to qualify for a loan as an individual? How does the remaining equity in the home compare to the financial assets and pension income my husband retains after the divorce? Click here to read more (link to article)

HOW CAN I INSURE THAT I’LL GET MY EQUITY IF MY HUSBAND REFINANCES?

If one partner wants to keep a jointly owned marital home, the other may negotiate a “buy out option” where the equity in the home is traded for a commensurate amount of equity elsewhere else. Sometimes this is paid via a mortgage refinancing, and other times you may keep more of other assets that are distributed. You should always consult an attorney before you sign any legal documents, though, to ensure you get what you are entitled to.

According to the mortgage carrier, you would be solely responsible for paying the mortgage and he has no responsibility. That’s often times why only one name is on the mortgage – so the other person’s assets couldn’t be seized to pay the mortgage. However, if the debt was acquired during the marriage, it’s likely you’re both responsible for it in the eyes of the Court. But if your husbands’ name is on the deed, he owns the house with you. Consult with an attorney about doing a "quitclaim deed" to have your husband removed from the deed.

If you own your home and it is in your name or held jointly, you have a legal responsibility to continue to pay your financial obligations. You also would have a legal obligation to pay any other expenses which are in your name. If your agreement is to share expenses using a 60/40 division and you move out and no longer pay your agreed upon portion, then you have not honored your part of the agreement. A Judge may order you to continue to pay these expenses.

It may be your spouse cannot afford to live in the home without your contribution to the financial obligations. Financially, if your spouse cannot maintain the home without your contribution, or does not wish to pay the additional expenses on his own, you could always explore alternative options. These options might include you both moving out of the marital home, you moving out but living with a family member or friend, while continuing to honor your financial obligations until you can move forward with your divorce.

Typically, banks require both parties to sign a loan secured by property jointly owned. The creditor would have a right to seize your assets if the debt obligation is not satisfied. Therefore, it is highly likely the bank will not hesitate to sell your land if the payments are not made. If neither of you can afford to pay the loan, your best bet is to sell off enough property to cover your debt.

The only way your husband could take cash out of the mortgage would be if the liability was in his name only. If this is the case, he is legally obligated to make the mortgage payments. If he does not pay, the bank will pursue him legally. If he does not comply, the bank will have the right to foreclose.

The question whether your husband has any liability to pay the bills or not depends on whether or not his name is on them alone or if you are both listed as responsible for payment. For example, if the mortgage is held jointly in both of your names, then legally you both have a responsibility to pay the mortgage note. The same would be true for the utilities and anything else. If the bills are not in your husband’s name, he has no legal responsibility to pay any portion of these. However, like many things, the Courts do not always care who has title to assets and debts. So, it’s important to consult with an attorney that can help address your specific situation.

If your divorce settlement stipulates you are to receive one-half of his profit sharing account, you will still be entitled to half, providing your husband has met some or all vesting requirements. Profit sharing plans, unlike IRA's are considered "qualified plans" and hence fall under the guidelines of the Employee Retirement Income Securities Act of 1974 (ERISA.) The Employee Retirement Income Security Act is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans. Over time important legislation has amended ERISA. The Retirement Equity Act of 1984 among other things, created spousal rights to pension benefits through qualified domestic relations orders (QDRO's) in the event of divorce.

Retirement accounts are divided in a divorce in one of two ways; either through the use of a Qualified Domestic Relations Order (QDRO) or the divorce decree. Knowing which way to divide a retirement account depends of the type of retirement account it is. Some courts apply the term "qualified domestic relations" (QDRO) to IRAs, but a QDRO applies to qualified plans and 403(b) accounts, not IRAs. For divorce settlements, the term "transfer incident" is applicable to IRAs. To ensure the proper language is used in the documentation, parties involved in a divorce settlement must be sure to inform counsel of the type of retirement plan they have.

In the division of IRA assets (or award to the spouse of the IRA owner) in accordance with a court-approved divorce decree or legal separation agreement, the division is treated as a non-taxable transaction, which could be a transfer or rollover depending on the financial institution. The spouse who receives the assets (referred to as "former spouse") is required to treat the assets as his or her own and is responsible for the tax implications of adding any distributions into his or her income for the year the distribution occurs. Should an individual give IRA assets to a former spouse without receiving a court-approved divorce decree or separation agreement authorizing the change in ownership, the individual will be required to include the amount in his/her income, thus treating the transaction as a distribution to him/herself.

When dividing IRA assets in the divorce decree, the document must address the retirement assets and stipulate how the division should be allocated, that is, whether the assets are shared equally, awarded entirely to one person, awarded partly to one person, etc. Some financial institutions require that the divorce decree reference the retirement account's number and the custodians name. It’s important you check with the financial institution regarding the requirements of the IRA and provide this information to the court.

If the retirement assets in question are part of a qualified plan, they must be divided via the use of a Qualified Domestic Relations Order (QDRO.) A QDRO is a judgment, decree, or order that gives a pension plan participant access to retirement assets that must be used to pay an ex-spouse or dependent children. One should consult an expert in QDRO preparation. It is important the plan administrator review and approve a QDRO to determine if it meets regulatory and plan requirements.

Typically, if an attorney has been hired to dissolve your marriage, they will conduct a formal discovery process. In the discovery process, each attorney requests information about the other spouse’s finances, assets, pensions and any other financial issues that are of concern.

If you don’t have an attorney and directly asking has provided a satisfactory answer, review past tax returns for clues as to what type of funds your husband has sold or received interest or dividends on during the calendar year. If your husband works for a company, his W2 will report any contributions to a 401k or company sponsored retirement plan. Your husband’s employee handbook will also contain information whether the company offers a pension plan or some other form of deferred compensation. Both will give you clues as to the existence of a plan, but it will not give you any specific information about your husband’s retirement plans. To receive this information you will need an attorney to subpoena it on your behalf.

When a couple seeks a divorce, they must decide how to divide their marital property, which would include a present value calculation of the pension benefit. There are many ways to divide a pension. One method is to compare the present value of the pension to other marital assets subject to distribution in an attempt to “trade-off” the benefit relative to another. In this case, the pension holder retains the monthly benefit stream of income and the spouse would take another marital asset of equal value to balance off the distribution. Another method would be to divide the pension benefits using a Qualified Domestic Relations Order (QDRO). In basic terms, a QDRO is a written set of instructions that explain to a plan administrator that two parties are dividing pension benefits due to an equitable, but not necessarily a 50/50 distribution. If you choose this method, it is important to have your QDRO finalized and approved prior to the divorce so your rights to collect this benefit will be protected.

Properly managing a divorce settlement is very important. You will want to preserve the assets you are awarded and prudently invest them so they can provide you an income stream in your retirement years. Consider opening an account with a brokerage firm. You can either choose a discount brokerage firm, like a Charles Schwab, or open an account through a Financial Advisor. Both can advise you on how to properly rollover your funds from your husbands 401k so you will avoid any tax penalties associated with the transaction. Deciding on how best to invest your money will depend on many factors such as, your age, your risk tolerance and your liquidity needs. The discount brokerage firms can offer some guidance, but you are more likely to get personalized attention if you work with a financial advisor.

If the loans are verified and enforceable, you may end up being partially liable for repayment even if you were not aware of the loans. For example, if you own a home and you default on a liability, an individual or creditor has the ability to put a lien against your home or file a pending lawsuit thus preventing you from being able to sell your home by tying up your home in litigation for years. However, if a creditor tries to seize your assets, you may have some level of protection for your assets. A Homestead Declaration is a legal agreement, which if filed, can protect a portion your home’s value from creditors (the amount differs by state). For example, if a person incurs an overwhelming gambling debt, a portion of your home’s value would be protected. This way, if a judgment is entered against your husband and his debts are forced to be re-paid, at least your home will be protected. As far as any other assets you may own, unless either of you had structured in advance certain asset protection tools such as family limited partnerships or LLC’s, then all of your assets would be vulnerable to any creditors.

Formally write your creditors to notify them of your impending divorce. Request they close the account, cancel the card and ask for a current statement so you have full knowledge of your joint liability. Send the letter certified mail and retain the delivery receipt in your records. And, if you haven’t already done so, establish a credit card in your own name as soon as possible!

Credit card companies don’t care who the purchases were intended for nor who benefited from them. When you established credit in your name, regardless of the reasons you did so, you are solely responsible for any purchases and therefore all liabilities. Credit card companies will not allow you to "switch" the account holder from one account holder to another. Depending on your relationship with your former spouse, you might consider having him establish new credit in his own name and then do a "balance transfer" from your account to his. This is not always an option if the two of you are not in agreement of what his liabilities are, or if he has poor credit.

If you’re divorced after at least 10 years of marriage, you can collect retirement benefits on your former spouses’ social security schedule. You need to be at least 62 and your former spouse must be eligible or is currently receiving benefits. The benefits you are entitled to receive are at the amount of 50% of your former spouses benefits and since your husband was the higher wage earner, most likely his benefit amount will be greater than yours. The exception to this rule is if you remarry. If however, your second marriage were to end later whether by divorce, death etc., you would again be eligible. The Social Security Administration is a great resource for questions related to divorce and social security benefits. To read more, click here (to Social security article).

There are many ways to dissolve a marriage without depleting everything you’ve built. The single largest factor influencing cost is the ability of both spouses to work together amicably to resolve the issues. If the parties can’t agree on anything, there’s generally little one side can do to keep costs down.

Recently, alternative dispute models have been gaining in popularity as a way to minimize costs. Mediation is often the least costly option, but it requires a couple to solve their own issues. A settlement is drafted and is based on what each party considers fair. An attorney is often used to review the paperwork. While it may be more cost effective in some instances, it would not be an appropriate choice if you believe your spouse is dishonest about finances.

“Collaborative law” refers to a new area where professionals help couples dissolve their marriage out of court. In short, each party has their own representation, but all professionals agree that they cannot represent you if you must go to court to resolve any issues. This avoids the perceived conflict attorneys have – that if they get paid by the hour, they’ll make more money if they litigate your case in court for days and days. If successful, collaborative law can often be less expensive than the traditional method of litigating.

Some couples chose to do their own divorce. This method is referred to in the legal community as “pro se”. While I always recommend you seek counsel, if costs are a concern you can always try to represent yourself in court.

Start gathering financial documents that show what your marital estate was worth before, and after, your husband deliberately sold your joint assets for his own benefit. Check the registry of deeds in the county where his home is located. All legal documents – titles, mortgages, quit claim deeds – are matters of public record. Bring the “evidence” to your attorney so they can present it to your Judge and/or the opposing attorney.

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