Kimberly Nelson, CFA®, CDFA, is an Advisor at Coastal Bridge Advisors, one of the many distinguished financial advisory firms on the Harness Wealth platform. She has been working with high net worth divorces in the Los Angeles area for more than 15 years. She understands the common challenges faced when navigating a bevy of attorneys, accountants, insurers and other advisors during the dissolution process, particularly before tax season.

Before Officially Filing for Divorce

It’s probably impossible to know exactly the right time to begin dissolving a marital partnership. It might be easier without the holidays looming, it might be easier on the kids in the middle of the summer rather than the middle of the school year, it might be better to wait until after his bonus hits the bank in April….I could go on. There are many reasons one could find to delay the inevitable, but while you’re waiting for the perfect moment it might behoove you to do a little homework first.

There are many issues you must prepare for before you serve papers to your former spouse, but today we are only examining the financial aspects of this daunting task – which very simply is all about getting organized. Organization is what you do before you embark on a greater task so that when you begin that journey of a thousand steps, nothing important is left unconsidered or forgotten entirely. Gathering up the information on your family’s assets before you file might make it easier to provide our attorney/CPA with the information they need to help set proper expectations for you when it comes to support/asset division, and to ultimately help you and your spouse reach an equitable resolution.

A helpful guide can be found here: Document Checklist: When You Are Contemplating Divorce or Separation 

Tax Filing Status: Single vs. Joint, Determining Head of Household

If you were in the process of separating but had not yet divorced before the end of the year occurred, you still have the option of filing a joint return or “married filing separately”. It’s the
year when your divorce decree becomes official that you lose these options. Essentially, what your legal marital status was on December 31st controls your filing status for that entire year.

If there are children involved, then whichever parent retains the right to claim the children as exemptions can file as Head of Household, which is the most advantageous filing status. With alimony no longer being deductible as of 2019, this could be hugely valuable. You can claim Head of Household if you have a qualifying dependent and provide more than half of their support. Under the new tax law, the standard deduction is $18,000 for Head of Household compared to $12,000 for single filing status. Determine which spouse would derive the greatest benefit from that deduction and make sure that the benefit is shared.

Also, keep in mind that capital losses can actually be carried forward into subsequent years as needed, until they are fully deducted. In a divorce scenario, capital loss carryovers are generally
allocated based on separate capital gain and loss calculations for each spouse to ensure that the spouse who suffered the capital loss is able to use the carryover for tax purposes. If losses were incurred jointly by both parties, the carryover should be divided equally.

Alimony: Front-loading and Child’s Age

Understand the rules about front-loading your alimony payments. If alimony payments are concentrated in the first year or two after divorce, the IRS may consider the money to be non-deductible property settlement.

Additionally, if alimony is scheduled to end within six months of a child’s 18th or 21st birthday, the IRS may consider the alimony, in reality, to be disguised child support. The different tax implications of a potential reclassification on these payments could wind up sticking a large tax bill on the payor of the support.

Retirement Plan Transfers

In order to transfer all or part of a qualified retirement plan as part of a divorce settlement, a court must issue a qualified domestic relations order (QDRO). There are no tax consequences if the transfer is structured appropriately as an eligible rollover distribution. When receiving a portion of a former spouse’s retirement account under a QDRO, the recipient needs to decide whether to keep it in the existing plan or whether to roll the funds into an IRA. QDROs do not govern the division and transfer of IRA assets. However, it’s possible to transfer IRA dollars using a trustee-to-trustee (direct) transfer with no tax consequences, as long as the transfer is related to the divorce. To be exempt from taxes and early withdrawal penalties, such transfers must be handled in accordance with IRS regulations.

All of this may seem like an overwhelming number of deadlines and tradeoffs to manage during what is already a busy time. Be sure to consult an advisor to help evaluate your individual situation and decide what timing for which actions makes the most financial sense for you and your family.

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Advisory services offered through Coastal Bridge Advisors, LLC (CBA). CBA is an SEC registered investment adviser and is not affiliated with Harness Wealth, LLC or Multiplier, Inc.

This article is provided for informational purposes, not as personal investment advice. There is no guarantee views and opinions expressed herein will come to pass.

This article contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

We are neither your attorneys nor your accountants and no portion of this material should be interpreted by you as legal, accounting or tax advice. We recommend that you seek the advice of a qualified attorney and accountant.