Tax & Financial Impacts of Divorce: 10 Mistakes to Avoid

Divorce is something no one hopes will happen to them when they get married. Unfortunately, almost half of all marriages end in divorce. Since few people have pre-nuptial agreements, most divorces involve often bitter tangles over children, money, and assets. When it comes to the tax and financial implications of divorce, often your divorce attorney is not the only one you should rely on for advice.

I have found ten very common mistakes that people make in the divorce process. A tax or financial pro can help you avoid them.

1. Don't let emotions guide you in determining the divorce settlement. Divorce is about a lot of things, but is caused mainly by emotional issues or financial problems in the marriage. You may love or hate your soon-to-be ex, but you cannot rely on your "gut" feelings that they will do right by you or the children. You must make the settlement using reason and planning for the unexpected. He or she may want to pay a large alimony and a small amount in child support by telling you they want to see you are "taken care of." That may result in less tax for them, a lot more taxes for you and destitute children should you die before they reach 18. Financial planning is critical.

2. Get a good family law attorney, but don't forget to hire a financial professional to assist in evaluating assets and financial strategies. It may cost extra fees, but it will result in a far better settlement for you in most cases. A Certified Public Accountant (CPA), Certified Financial Planner (CFP), or an Enrolled Agent (EA) can be of invaluable help. What is the house really worth? If a business is involved, what are the consequences of its disposition or the true value of it in the divorce settlement? Your spouse might tell you their business is losing money or has no assets; you need to know the truth!

3. Getting the house in the divorce is not always a good deal. Women often want the house in the divorce because they are raising a family in it or have decorated it and are emotionally attached to the property. If it has a mortgage attached to it, think long and hard about the house. It might be better to sell it and split the equity. If you aren't working and are raising kids, do you really want a big mortgage payment?

4. Failing to fight for the most child support you can get! Large alimony and low child support payments are generally not a good deal to the spouse getting the payments. Alimony is tax deductible to the party paying but taxable to the party who receives it. A large payment is a large tax deduction for one party and a big tax burden to the person getting it. Child support is tax free to the recipient and not deductible to the payer. Also, alimony may terminate upon marriage or death, but Child Support continues until the child reaches 18.

5. Failure to specify who can claim the kids on the tax return. The divorce should specify who will be entitled to claim the children. Also, Form 8332 Release of Claim may need to be filed with IRS in some circumstances.

6. Lack of planning with regard to life insurance. Life insurance should be reviewed in the event of divorce. You may want to take your ex off of your policy as beneficiary, but do you really want to make your children beneficiaries? Unless they are over 18, this can be a big mistake as the funds may go to a trustee until the kids reach majority. Consult with your attorney on how to style your life insurance to best provide for the kids. If you are the person getting alimony or child support, it is a very good idea to carry a life insurance policy on your ex in the event of death. Otherwise the money stops coming and you may end up homeless.

7. No income modeling done in the calculation of alimony. Your spouse may be a corporate executive and have great future earning potential. He or she may have stock options. An income model should be made to determine the potential they have and how it can affect your claim in the divorce.

8. Failure to secure a Qualified Domestic Relations Order (Quadro) in the event of a 401K or other tax impacted investment that is divided in the divorce. If you don't do the right thing, huge tax penalties can be imposed on taking money out of IRAs, 401Ks, or Annuities. A good family law attorney can help with this but your Uncle Joe who handles bad check defense may not be the guy you want to do your divorce. He or she may not be familiar with a Quadro.

9. Failure to have assets professionally appraised. If you have rent houses, oil and gas investments, etc. Get a professional valuation or you may be cheated in the divorce settlement. The spouse who handles these investments may not be honest with you on the values. Just because he or she loves the kids or was married to you for thirty years does not mean you can trust them.

10. Lack of faith in yourself and your future. Divorce is bad but it is not the end of the world! You may have some tough times but your life will go on and it may be a blessed life. You don't know what tomorrow brings. It may bring love and happiness. You must have faith in yourself so that you can take care of the kids and be successful in whatever you choose to do. Money is not everything, but if you don't have faith in God and yourself, you won't be financially successful.

Well that is my list and it is my prayer that it has helped you in some way. Be strong and be forceful. Don't get walked on!

J.R. Coleman, E.A., A.T.A.

James Robert Coleman, E.A., A.T.A.
Enrolled Agent & Accredited Tax Advisor
Member: National Association of Enrolled Agents
Former IRS Revenue Officer, GS-11

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