Marital dissolution can have severe financial consequences if there is insufficient attention given to asset preservation in divorce. One of the best options is a pre- or postnuptial agreement, which may be part of a business succession and estate plan. Still, many couples do not recognize the need for asset preservation in divorce until they are facing a marital separation. It is never too late, but the options are more limited when a divorce is imminent. In my book, Frumkes & Vertz on Divorce Taxation, we examine the principal techniques for achieving asset preservation in divorce.
Through careful planning and cooperation, spouses who are separated or divorcing can minimize their tax liabilities, which helps with asset preservation in divorce. For instance, alimony is an effective way of shifting taxable income from the payor’s tax bracket into a lower tax bracket for the alimony recipient. By reducing taxes, there is more net income available to share. This technique is effective when the payor earns more, and is in a higher tax bracket, than the recipient. It also requires the payor to overcome the distaste of paying alimony.
Along similar lines, divorcing spouses must consider how to deploy tax deductions and credits most effectively. A custodial parent might want to retain the children’s dependency exemptions to reduce taxes, but the other parent might get a greater benefit if he or she is in a higher tax bracket. On the other hand, if the exemption would be phased out, then it should be retained by the parent who can actually use it.
When dividing marital property, divorcing spouses can take advantage of the tax exemption for property transfers between spouses. Still, they must be careful not to trigger tax liabilities unintentionally. For instance, spouses may be able to withdraw funds from a retirement account by using a qualified domestic relations order, without incurring the 10% penalty for early withdrawals. But, if they move 401K funds to an IRA first, and then withdraw, they will be hit with the 10% penalty.
Redemption of corporate stock might be risky, as noted in Chapter 2 of my book. Prior to 2003, there were two published decisions in which one spouse conveyed stock to the corporation itself (instead of the other spouse) and received payment for the stock; and these transfers were qualified for non-recognition of taxes. But, in 2003, the Treasury Department issued Reg. 1.1041-2, which created the power to elect which spouse would be charged with a taxable distribution upon the redemption of corporate stock.
A divorce creates opportunities to achieve tax savings or fall into a tax trap. If one of the primary goals is asset preservation in divorce, then it is important to avoid unintended tax consequences, which can arise at any stage of a divorce proceeding.
Brian C. Vertz has represented all kinds of people with complicated child support and divorce issues. His law firm is a powerful team of lawyers dedicated to family law. In Pittsburgh and Western Pennsylvania, call Brian at 412-471-9000.