Key Financial Issues in Divorce

As a professional helping couples deal with divorce, you face a number of financial issues.

It is also critical that you help the parties look a bit further down the road.

The moment of the property, child support, and alimony settlement fixes the financial arrangements between the parties, often forever.

In this section, we highlight the key financial planning issues for divorce.

Key Financial Issues: Budget

Many of the parties to a divorce have never created a budget before. So they will want to know:

With Family Law Software, you will be able to help your clients address all these questions.

Often in a divorce, each side thinks the other side is doing spectacularly well.  Occasionally that’s true, but more often it’s not.  Family Law Software allows you to present graphic proof of the actual situation to both sides.  And that can help them get to settlement that much sooner.

Helpful Hint: Asking “What If.”  At any time, anywhere in the Planner tab, you may ask “What If” by clicking the Totals  button at the top of the screen (on the right).  You may then enter the data differently, click the Totals button again, and see the effect on the income and asset results.  This can let you see the impact of cutting or switching specific Living Expenses, for example, alimony, support, who claims the home, or any other financial issue.

Key Financial Issues: Real Estate

In a divorce, at least one party has to move out of the marital home.  Sometimes both parties do.  This move raises several questions:

As we will see, Family Law Software allows you to plan for selling now or later, buying now or later, and renting now or later.

If you represent the client who will be staying in the residence, one of your tasks may be to prevent that spouse from giving up too much in order to retain the residence.  The software can help you do this by presenting equitable outcomes in “black and white.”

This flexibility lets you design a plan of action that is right for the parties.

Key Financial Issues: Property Division

If there is any property, the parties will have to divide it when they get divorced.

Your goal may be to get as much property as you can for your client, or it may be simply to assure a fair result.

In either case, the software’s property division screens will help, by letting the parties clearly see the alternatives, quickly get to a desirable overall allocation, and quickly trade off one item of property against another. 

The key screens, which are discussed in the body of this guide, are the Marital Property Division screen and the Scenarios screen, both of which are found on the Lawyer and the Negotiate tabs.

You may know that you are aiming for a division of, say, 50/50…but is that 50% of all property, or just marital property?  And how do the parties decide who gets which property?

Key Property Division Issues: Marital vs. Separate Property

In almost all cases, each item of property is categorized as either “marital” or “separate.”  (In community property states, marital property is called “community” property, but the approach to property division is surprisingly similar.)

In a divorce, typically, the separate property is “off the table” in property division discussions.

Which property is “separate?”

Separate property includes property owned previously, and inheritances during marriage.  To remain separate, it must be kept in separate accounts and not used to pay joint expenses.  Gifts from one spouse to another (e.g., jewelry) are typically separate property.

We say “during the marriage,” but the date that signifies the “end of the marriage” for separate property purposes is rarely the date of the divorce.  Most commonly, the end-of-marriage date (called the “separation date”) is the earlier of the date one party moved out or the date a divorce action was begun.  But the definition of the “separation date” varies from state to state.

Marital property is that which is earned “during the marriage.”  It includes salaries, stock, and stock options of both parties, regardless of which party held the job.  It includes the home, if the home was purchased during the marriage with funds earned during the marriage, even if only one party worked.

Many times, a single item can be partly marital and partly separate.  A residence which was purchased before the marriage, but whose payments were made during the marriage can be partly separate and partly marital.  A retirement account that was begun before the marriage is also partly marital and partly separate.

Family Law Software lets you specify for each asset how much, if any, of the asset is separate property.

Note that if one party has a lot of separate property, a judge may look at that fact, and award the other spouse more of the marital property, in order to make the overall division more fair.

So although the separate property is “off the table,” its presence may be felt in the division of the marital property.

Key Property Division Issues: Dividing Marital Property

A benchmark in long-term marriages (typically marriages of over ten years’ duration), where both parties were fully occupied with either work or children, is that marital property will be divided 50/50.

But there are any number of reasons why this would not apply, depending on the exact circumstances.

Also, if there is a significant amount of separate property, a judge may award one spouse more of the marital property in order to make the overall division fairer.

So you need to look at both the division of marital property and the division of total property.  Family Law Software shows you both the marital property and the total property division.

People tend to want to keep the assets they feel they “earned,” such as IRA accounts or defined benefit pension plans.

But this is not always the best way.

Family Law Software lets you easily try out different combinations of property, to reach a settlement that is acceptable to both parties, as quickly as possible, using the Property Division negotiation screen.

Key Financial Issues: Child Support.

In every state, there are formulas that determine the amount of child support it is necessary to pay.  These formulas are called “guidelines.”

Despite the mechanical nature of the calculations, there are points of flexibility.

Child support is not always simply the mechanical application of a formula.  Here are some of the reasons:

In the software, we calculate a number of states’ child support guidelines in detail.  To see if your state is one of those, click the Guidelines tab, then Select State on the left.

Key Financial Issues: Alimony.

Unlike child support, which has a significant state involvement, alimony is almost always purely the result of the negotiation between the parties.

In a few states, including California and Pennsylvania, there are alimony formulas.  But even there, the alimony calculated is usually intended to be only temporary.

Different states have different attitudes to alimony.  Some states are inclined to award lifetime alimony after ten-year marriages in which the recipient stayed home and supported the family. 

Other states are not inclined to award any alimony at all, or will award alimony of only a few years, intended to allow the recipient to train for a career (often called “rehabilitative”alimony).

One key concept is the “alimony break-even amount.”  This is simply the amount of alimony that will enable the recipient to just break even after expenses and taxes.  The software has negotiation screens (“Scenarios” and “Support What-If”) that help you find that amount.

Another key alimony issue is the present value of the alimony.  What amount today equals the value of the stream of alimony payments?   The software calls this the “alimony present value,” “alimony PV,” or “alimony buyout” amount.

The alimony present value amount is important because sometimes one party or the other will prefer to receive the alimony all at once, rather than monthly over time.

The software calculates the alimony buyout amount for you on the “Alimony PV” screen.

Key Financial Issues: Education.

If the children are young during the divorce, the children’s college is often the furthest thing from the parties’ minds.

But children of divorce miss out on higher-quality four-year colleges much more than do their peers from intact families.

And this is often the case despite the fact that one of the parents can afford to pay.  If a parent can afford to pay, this is the moment to think about it, and get that commitment.

More immediately, there may be private schools for the children, or education for one (or both) of the parties.  You want to plan for this as well.

Key Financial Issues: Retirement.

If one or both parties are nearing retirement age, then the financial picture will change – sometimes dramatically – when retirement comes.

As a professional considering the parties’ financial future, it is critical that you help them understand what the impact of retirement will be on the income flow.

In retirement the following things happen:

You will want to look at the total picture when retirement comes, in order to plan wisely for your clients now.

Key Financial Issues: Tax Issues

The calculation of taxes is complicated and difficult – it’s a good thing there’s software to handle it for you automatically!

This section gives you a brief overview of the key tax issues, so you can be aware of the issues you might wish to consider when you are helping your clients make decisions.

A basic sense of the issues presented here, together with the software to do the various computations, can help you make smart tax recommendation on behalf of your clients.

Key Tax Issues: Claiming the Exemptions

The person who claims the children as exemptions on his or her tax returns normally gets a deduction for doing so.  That deduction reduces taxes, and thus puts cash directly in that party’s pocket.

Typically, a higher-income taxpayer can save more tax.  That’s because the higher tax bracket yields more in terms of tax savings.  This additional saving can then be split with the other party.

However, there are exceptions.  At very high incomes (which vary from year to year, based on inflation and the latest tax laws), the deduction for the exemptions disappears.

The software can help you determine which party would benefit most from claiming the exemptions, and the amount of the net tax benefit in the “Exemptions” report.

Key Tax Issues: Tax Filing status

The parties have to make two key decisions about tax filing status.

The first decision is whether they should file jointly or separately in their last year together.  (In some cases, this becomes a decision whether to divorce at the end of a tax year, or whether to postpone the divorce to the next year, in order to get one more year of joint tax filing.)

The second decision is what filing status to use after the divorce.

These decisions don’t affect anything, other than tax payments, in the “real world.”  So they are ideal decisions for using software.

The software can help with both decisions, and it can tell you how much of your clients’ tax dollars you may be saving, using the Filing Status report.

Key Tax Issues: Alimony Tax Deductible

Alimony is tax-deductible to the payer. 

It is included in the income of the recipient.

The software reflects these tax effects automatically.

Key Tax Issues: Alimony Recapture (Alimony vs Property Settlement)

If alimony declines too much over the first three years, it will be treated as a property settlement instead of as alimony.

In tax parlance, the tax deductions for alimony are “recaptured.”

Alimony recapture is designed to find people who try to disguise property settlements as alimony.  (The parties would want to characterize the payments as alimony, rather than property settlements, to get the tax benefits of the alimony deduction.)

In general, the tax law of alimony recapture says that if the payments labeled as "alimony" decline "too quickly" over the first three years, then some of the alimony will be recategorized as a property settlement.  The tax deduction is then taken away.

Because the determination of whether the payments are alimony does not occur until after the third year in which alimony is paid, tax writers say that the government "recaptures" the alimony deduction.  Hence the name "alimony recapture."

How much of a decline is too much?  Here's a quick test: if, by the end of the third year, the alimony has declined by more than $15,000 from the first year, then some recapture may apply.

The software will automatically check for recapture.  If there is recapture, the software will estimate the tax amount.  (See the “Alimony Recapture” report.)

Key Tax Issues: Alimony vs. Child Support

If the payer is in a higher tax bracket than the recipient, then there are net tax savings to labeling a payment as “alimony” instead of “child support.”

To take a simple example, suppose the alimony payment is $10,000 a year.

Suppose the payer could save tax of 38%, or $3,800.

Suppose the recipient could pay tax of 15%, or $1,500.

Between the parties, the tax savings to labeling the payment “alimony” instead of “child support” is $3,800 minus $1,500, or $2,300.

That’s free cash, which can then be divided between the parties.

Of course, the government does not want people to take advantage of this tax arbitrage.

So there are many requirements for payments to be counted as alimony.  The key requirement is that the payments may not be related to events in the life of any child of the marriage.

If an alimony payment stops when the child turns age 18, starts college, starts work, marries, leaves home, etc., then the IRS may recharacterize the payments as child support.

For a complete discussion of this matter, go to the Alimony screen (on the Lawyer or Planner tab) and click the pop-up help at the bottom.

Key Tax Issues: Mortgage Interest Payments

Mortgage interest payments are typically deductible only by the person who lives in the home.

So as you plan, you want to have the person who actually makes the mortgage payments be the person who lives in the home.

Also, mortgage interest is deductible only for a main or second home.

Key Tax Issues: High-Basis vs. Low-Basis Assets

The tax “basis” is essentially the cost of an asset.

When an asset is sold, the government taxes the gain, the difference between cost and sale price.

Consider two identical mutual fund investments, both worth $50,000.

The naïve view is to think it does not matter which your client takes.

But suppose one cost $10,000 and the other cost $35,000.

When the first one is sold, there will be $40,000 of gain to tax.  When the second one is this sold, there will be only $15,000 of gain to tax.

We say that the first one has $40,000 of built-in gain.  The other one has $15,000 of built-in gain.

You want your client to have the second one, because less gain means less tax to pay.

So, all else equal, you want your client to have the high-cost low-gain assets.

This is important especially for securities and real estate.

After you enter the value, cost basis, and proposed division of all assets, the software is able to show for you the amount of total so-called “built-in gain” for each party.  Just click the Planner tab, then Graphs on the left, then Built-In Gain.

You can also allocate securities on the fly to equalize built-in gain.  Click the Negotiate tab, then Securities Gain.