When two spouses divide assets in a divorce, it is important to pay with attention to the tax consequences connected with certain assets. The clearest example is retirement assets. Usually, when someone receives a payment or distribution from a retirement account, it is a taxable event. So, someone in a twenty-eight percent tax bracket, who receives a $3,000 payment from a retirement account will pay tax of $840 on that payment. Essentially, instead of receiving $3,000, the person will receive net value of $2,160.
If in a divorce, one spouse receives a bank account with $3,000 and the other spouse receives a retirement account with $3,000, it may appear to be an equal award of property. But since the bank account funds do not involve tax consequences, and the retirement funds do involve tax consequences, the division of assets is not really equal.
On a larger scale, this can have a substantial impact on the fairness of a property division. If one spouse is awarded the marital homestead, with estimated value of $300,000, and a $200,000 mortgage, that spouse is essentially receiving a $100,000 asset. If the other spouse accepts a $100,000 retirement account in exchange for the equity in the house, he or she will not be able to make use of the retirement funds without dealing with the tax liability connected with the retirement funds. Assuming thirty percent tax liability, the spouse awarded the retirement account ends up with essentially $70,000, instead of $100,000.
It is common for the property division to be adjusted to provide for a fair division of assets that accounts for taxes. For instance, in the above example, each spouse could be awarded $50,000 from the retirement account (and each consequently paying their own respective share of the taxes); and the spouse not awarded the house could be given a $50,000 lien on the house (or the house could be sold, and the proceeds divided equally).
In other cases, the property division might not be adjusted because other aspects of the property settlement are favorable in some way to the spouse receiving the taxable retirement asset. What is important is for both spouses (and/or the family court judge) to be aware of the tax effect, and to make a purposeful decision about how to devise a fair property settlement in light of those consequences.
This is great information. Too many attorneys don’t discuss the tax ramifications of the divorce. This is a great example of one area that needs more focus.
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