The Financial Impact of Divorce: Understanding Your Income Taxes

Many challenging issues can arise during a divorce. One you can’t avoid would be paying your taxes. The question is, how do you handle them?

Dissolving a financial partnership, particularly one as intricate as a marriage, is a complex process that involves significant tax implications for soon-to-be former spouses. Couples will typically need to divide their assets - oftentimes that have greatly appreciated in value over the years. The process of uncoupling these investments can be challenging, especially during emotionally charged times. A practical mindset, education, and meticulous preparation are essential for navigating this process

successfully.

The Basics

1. Evaluate Your Filing Status: Your eligibility to file jointly is closely tied to the timing of

your divorce. If you:

•  were legally separated or divorced by December 31, you are required to file as single for that tax year, unless you qualify to file as head of household 1 or if you remarry 2 before the year ends.

•  have not yet legally separated or divorced by the end of the year, the IRS considers you married for tax purposes until a final decree of divorce or separate maintenance is issued.

2. Asset Division: The distribution of assets is primarily governed by your state laws and any pre- or postnuptial agreements you may have. Judges strive for an equitable division of assets, carefully considering the length of the marriage and the financial contributions of each spouse. Understanding these nuances can empower you to advocate effectively for your rights in the process.

Tax Treatment of Different Assets

1. Cash Transfers: Transfers of cash between spouses, as per divorce agreements, carry no tax implications, making it easier to manage finances.

2. Real Estate: Each spouse can benefit from a $250,000 exemption on capital gains from the sale of a primary residence ($500,000 if filing jointly), provided you meet the necessary residency requirements.

3. Brokerage Accounts: The tax consequences of selling assets depend on how long they’ve been held. Gains on assets held one year or less will be taxed as ordinary income (up to 37%). In contrast, assets held longer than a year are taxed at long-term capital gains tax rates of 0%, 15%, or 20%, depending on your income, and may be subject to an additional 3.8% net investment income tax if your modified adjusted gross income is above certain thresholds. If you evenly split a portfolio between two spouses but one earns substantially more than the other, the higher-earning spouse could wind up with a lower after-tax value.

4. Employee Stock Options: Stock options granted during marriage are generally considered marital property, even if they vest after the divorce. Courts may differentiate between options earned for past work (marital property) and those granted for future performance (separate property). For the most part, stock options and restricted stock units (RSUs) are treated as marital assets during a divorce. Their division isn’t typically straightforward due to issues like vesting schedules, valuation, tax implications, and state laws. Some states treat unvested options differently depending on whether they are tied to past or future performance. Even if the options vest after the divorce, they could still be considered marital assets.

5. Jointly Held Businesses

A business is typically viewed as marital property and is subject to division according to state laws regarding equitable distribution or community property.

Here are two constructive approaches to consider:

1.  Selling the Business: The business can be sold, allowing the proceeds to be distributed like any other financial asset, while considering the associated taxes that may apply.

2. Buyout Option: One spouse may choose to buy out the other’s share, either with cash or through assets of equivalent value. While determining the business's value can present challenges, this option allows both parties to agree on a fair valuation. It’s essential to note that the selling spouse may be subject to taxes on capital gains, which could affect the overall asset value. For the buyer, the cost basis will be adjusted based on the buyout valuation, which may enhance the business's value over time.

Proactive Post-Divorce Actions

Once your divorce is finalized, promptly update your filing status with your employer

using Form W-4. This step ensures your withholding aligns with your new financial

situation. Additionally, consider consulting a tax advisor to gain insight into your new tax

landscape. As single filers typically face higher tax rates compared to married couples

filing jointly, a qualified tax professional can assist in maximizing your tax efficiency,

helping you retain more of your income during this transition.

For more information or to arrange a consultation, please get in touch with Jason Cole

at Full Court Strategic Wealth.

The Second Act Money Guide Blog appears once a month. If you have questions or

need advice, please get in touch with Jason Cole at Full Court Strategic Wealth at

267.970.6464 or jcole@fullcourtstrategicwealth.com. Visit the website

at https://fullcourtstrategicwealth.com/.

1 Head of Household (HOH): This status is often more advantageous than filing single, but you must meet all of the following

requirements:

•  You are unmarried (or considered unmarried) on the last day of the year.

•  You paid more than half the cost of keeping up your home for the year.

•  A qualifying person, such as your dependent child, lived with you in the home for more than half the year.

2 Remarriage: If you legally divorce and then remarry a new spouse by December 31, you can file a joint return with your new spouse.