Income Taxes in Divorce: Don’t Leave It to Chance  

Everyone worries about taxes but nobody really likes to talk about taxes unless, of course, they are running for political office.

Yet, like it or not, those who are separating and divorcing not only need to consider the future Impact of taxes on their post-divorce income but also on how to structure their divorce agreement to minimize the impact of taxes on the family as a whole. Admittedly divorce lawyers do not focus on the family’s tax burden; their job is to focus on minimizing his/her client’s tax burden. Yet, if you sit back for a second and think of the meaning of the disparity that I have just identified, it becomes quite clear that a united effort to minimize the family’s taxes produces bargaining opportunities that may not only facilitate arriving at a final settlement, but may well produce an economically more advantageous agreement for the family.

Let us consider some of the tax issues that may be worthy of negotiation.

1. Cash Settlements:

In many divorces, there is a transfer of funds from one party to the other. Cash settlements can be structured to:

• Buy out one party’s interest in marital property, such as a house or retirement holdings
• Buy out of an obligation to pay alimony
• Pay a debt or obligation

How transfers are affected should be carefully considered. For example, payments made in full, sooner rather than later, may be discounted for present day value. Payments made in installments over time may be adjusted for interest lost.

Moneys used to make payments may also require adjustment. Payments with retirement funds, instead of cash, may require adjustment for future taxes owed or conversely for tax-deferred growth over time.

2. Tax-related Child-Benefits include head of household status, education credits/deductions, child tax credits, child care credits and so on The apportionment of child-related benefits depends on a number of factors, including how payments are made and by whom as well as eligibility for the deduction/credit.

3. Payments for mortgage interest and real estate taxes for jointly owned property or for benefit of the other spouse carry tax savings to be considered. And, of course, in calculating each party’s post-divorce income, payments which affect each party’s future tax bracket should be incorporated into the calculation of post-divorce income, including retirement savings, health insurance payments and the like.

4. Since the banishment of the alimony payor’s entitlement to deduct alimony, a tax advantage that allowed the payor to pay more and the recipient to receive more, each party needs to calculate his/her income after payment of alimony. In addition, although child support was always paid in after -tax money, the impact of such payments cannot be neglected. In short parties should know how much money they will have each month to pay his/her budgetary outlays. Focusing solely on gross income or money to be paid or received without consideration of taxes is not only foolish but potentially injurious. Each party needs an accurate depiction of what he/she, as an individual, can afford for himself/herself and for any other dependents, including children.

The problem -solving approach inherent in the mediation process provides an environment conducive to weighing tax options in various scenarios. The objective should always be to identify ways to minimize the family’s tax burden. In situations where one party benefits and the other does not, provisions should be included to ensure that the “disadvantaged party” is made whole. Indeed, the mediator’s role should include helping couples to analyze the financial ramifications of their agreement now and after divorce. Getting to “yes” should be a conscientious and conscious approach routed in financial truths.