Why use a financial divorce professional?

Why should you use a financial divorce professional? There are many of them who have been trained in the specific financial and tax aspects of divorce. They can help save you money and help your attorney get you a more equitable settlement. The reports that a financial divorce professional provides gives you information about the financial result of any given settlement that you and your spouse may be discussing. This helps you make better decisions and the ultimate result is that you stay out of court. The two of you make the decision - not the judge who doesn't know you.

In the rare instance that you and your spouse cannot come to an agreement and you decide to go to court to have the judge make the final decision, the financial divorce professional has been trained to appear as an expert witness in this situation.

Divorce tax laws

Would you like to be an expert in divorce tax law? Find out how to learn the divorce tax secrets that even many divorce lawyers don't know! Go to www.FDAdivorce.com/tax.

Do-it-yourself divorce mistake #3

Chang and Tip Tum had come to America many years ago and had opened a restaurant which become hugely successful. After 24 years of marriage, they wished to divorce. Even though they were now worth millions, their thrifty habits influenced them to do the divorce themselves and not spend money on lawyers. In dividing their assets equally in value, Chang took the stock accounts and the retirement plans and Tip Tum took the real estate. Even though Chang earned ten times what Tip Tum earned, he offered her only 3 years of maintenance while he convinced her that her assets were enough for her to live on.

They drew up their agreement, filed it with the court and their divorce became final. Tip Tum's real estate took a bad turn and soon she didn't have enough to live on. She decided to get some professional advice. She learned that a property settlement is final and cannot be renegotiated. However, there was hope that the maintenance issue could be re-opened.

An interesting sidelight in this case is that it appeared that Chang had not revealed one of his large retirement plans. Because of that omission, it is possible that the property division may be re-opened! This case is still open so I cannot tell you the ending yet. But the important point is that even though you may think you are saving money by doing it yourself, the risks you take by not getting proper advice to start with can cost you much more money in the long run!

Do-it-yourself divorce mistake #2

Jim Suits, President, Summit Capital Advisors (jsuits@summitcapitaladvisors.net) had this story to tell after reading the last entry:

"Your last blog entry reminds me of a case we had where a tax client who came in to have his taxes done. He and his wife of 30+ years had gotten a divorce the year before. To save attorney fees, they downloaded the forms and "filled in the blanks" without help. The husband took them to an attorney and asked: will this work? The attorney looked at the papers and said: Yes.

"One item in the divorce stated that the wife was entitled to 50% of his 401k. So, after the divorce the husband withdrew her 50% from the account and wrote her a personal check. It was after that, that he came in to have his taxes done. Imagine his surprise when he was hit with early withdrawal penalties and income taxes totalling more than $100,000. Then came that famous question "Why didn't someone tell me?"

"(Because you wanted to save a nickel, that's why!)"

Do-it-yourself divorce mistake

When Michelle and Scott got divorced, they didn't want to spend money on an attorney so they got the forms and did it themselves. They had no children so the only issue was dividing the property. They decided to split all of their assets 50/50 and their final agreement stated that "they would divide each asset equally." Their assets included a $24,000 savings account and a $104,000 mutual fund, both in joint names.

After the divorce was final, they each had pressing business issues and kept putting off the paperwork needed to divide the two accounts. After a year had passed, Scott finally found time to get the savings account and the mutual fund divided. Imagine their surprise when they were hit with gift taxes!

The Tax Reform Act of 1984 says that transfer of property is incident to divorce if it occurs within one year of the divorce OR the transfer is stated in the divorce decree and occurs not more than six years after the divorce.

They could have avoided the tax problem they found themselves in if they had consulted with an attorney and (1) stated in their final agreement the specific assets that were to be divided, or (2) realized the importance of dividing the assets within the first year after divorce.

Is there additional income?

Janine was getting divorced from Mark, a highly paid executive who worked on Wall Street in New York City. They couldn't reach a settlement and in February of this year, we were ready to go to court to have the judge decide. Mark showed on his financial disclosure that he earned $500,000 per year.

I was the Financial Divorce Expert on this case and after we reached the courtroom, I was given a copy of Mark's W-2 for his 2006 wages. After looking at it, I was able to get on the stand and testify that Mark's yearly income was actually $600,000!

If you will look at a W-2 form, you will notice several boxes. Box 1 shows "Wages, tips, other comp." Box 2 shows "Social Security Wages." Box 3 shows "Medicare wages and tips." On Mark's W-2, Box 1 showed $500,000, which is what he was reporting. But Box 3 showed $600,000. Why the difference? It is because Mark was contributing $100,000 per year to his retirement plan which was deductible so that Box 1 showed only his taxable wages.

Because I could testify that Mark still owned that $100,000 - it was just in a different account (his retirement account) - he had that much more money to use toward paying alimony.

The Judge ordered sizable alimony for Janine, her attorney was surprised, and everyone was happy (except Mark!).

Divorce money saving tip

Here's a tip that most people don't know about. More and more people are now buying long term care insurance. The lower earning spouse in a divorce may be especially concerned about how to pay the bills if they have to go to assisted living or a nursing home later in their life.

Michelle and Kyle were getting divorced. Michelle was very worried about growing old by herself and what would happen to her if she became ill. She found out that if she and Kyle applied for long term care insurance before they divorced, they would get a "couple's" discount of up to 30-40%. And after the divorce was final, the premium would not go up - the discount still applied so they both saved money.

But what if Michelle wanted the long term care insurance and Kyle didn't? Michelle could still get a couple's discount but it would be lower - perhaps only 15-20%.

Every little bit helps and over years of paying premiums, this discount can really make a difference!

Modification of Child Support

Kate and Alec had two children, ages 5 and 7, when they divorced. No matter what Kate said, Alec refused to include in their divorce agreement a clause which would increase child support each year by inflation. As the children grew up, they became more expensive and Kate was having trouble making ends meet. She contacted Alec to tell him about her situation and how much the children's expenses had increased. Alec said, "So sue me." So she did.

After being served with a court date, Alec reluctantly agreed to increase child support to the amount according to the child support guidelines, using his current income and the children's current expenses, not the income and expenses at the time of the divorce.

Every parent knows first hand, the expense that goes into raising a child in this day and age. This becomes an even more daunting expense when two incomes suddenly become one. Children often become pawns in the midst of divorce proceedings, whether intentional or not.

Remember---child support is ALWAYS modifiable.

Research the value of retirement assets

Janet and Kevin are in the midst of a divorce. Kevin has a defined benefit pension which will pay him $2,300 per month when he retires. Janet decides that a few thousand dollars is not worth fighting over - besides she would rather get the $12,000 baby-grand piano they recently purchased for their den.

Wrong decision. Janet has made a costly mistake. Why? Because the present value of Kevin's pension is more than $250,000! Instead of taking the piano, she could have exchanged her half of Kevin's pension upfront for $125,000 worth of another asset, leaving Kevin with is pension. Or she could have chosen to wait until Kevin retires to get her part of the marital portion of his benefit. What seemed to have only been a few thousand dollars on the surface, proved to be a costly mistake in the end.

To get a FREE report "Top 10 Money Mistakes in Divorce," go to www.carolannwilson.com.

Dividing assets in a divorce

Dividing your property can be one of the most challenging and convoluted aspects of your divorce. What appears to be an easy decision such as I want the house, you keep the cars, may in the end deliver you a settlement you hadn't bargained for.

Janet and Jake are getting divorced and they are both age 64. They had two assets: a 401k worth $120,000 and a money market worth $120,000. Janet was really concerned about retirement and wanted to take the retirement fund. It felt more secure to her. Two years later, they each wanted to buy a small house. Jake took $90,000 for a down payment out of his money market fund to make the down payment on his house. Janet asked for $90,000 from the 401k to make a down payment on her house but the net amount she realized was only $60,000 due to the taxes she owed on money from a retirement fund!

Remember that you cannot compare a cash account with a retirement fund because of the tax issues. This is one area that many people do not think about.

Big mistake in divorce

There are lots of mistakes made in getting divorced. Let me tell you about one of my very first clients.

During their marriage, Joyce's husband had done all of the investing of their money. He had chosen all of the investments, and made all of the financial decisions. At divorce time, he said, "Let's just split everything 50/50. You take this half of the investments and I'll take that half. Is that okay?" Joyce thought that sounded pretty fair so she agreed. She talked to her attorney and the attorney thought it sounded okay, too.

Joyce came to me after the divorce to do a financial plan and I saw what really happened. What no one realized - Joyce, her attorney, and the judge - was that Joyce's half of the investments included all the limited partnerships. They are known to be illiquid and high risk. She couldn't get at the money - it was all tied up for years. And the worst part was that she owed an additional $18,000 in taxes because of the way the partnerships were structured!

If Joyce had only come to me before her divorce was final so that I could look at the assets, I could have explained to her how the different assets worked and she could have made a more intelligent decision.

It is so important for people going through divorce to consult with a trained financial divorce professional. We often know more about their assets than their attorney!

Problems with dividing a business in divorce

Joyce was married to Carl who owned a large business in Denver. During their divorce proceedings, the value of the business was furnished by the CPA who worked for the business. He said the value was $360,000. We wanted Joyce to get the business appraised but she was nervous about the high cost of an appraisal (about $4,500). Then Joyce said, "Do you think it really could only be worth $360,000? I worked there last summer and I know they take in several million dollars a year."

Well, we finally talked Joyce into getting the business appraised by an outside appraiser. The final value came in at $850,000 - a good return on her investment! Lesson: Don't use an employee of the business to give you the appraised value, especially if he works for the other side!

The worst case of dividing a business

But the worst situation of dividing a business was one I was involved with on the East coast. The husband owned a large business that he said was worth $6 million and that the wife would get half - or $3 million. We tried to convince her to get it appraised, but husband was threatening to make trouble over the children if she messed with his business and she didn't want that. He did offer to pay her $10,000 per month for 10 years so she could continue her lifestyle without having to work. She thought that was fair. No matter what we said to her, she was firm and she took his offer.

Result? Within 6 months, he sold his business for $67 million! Now you know, he must have been in the middle of negotiations when the divorce took place.

Another response about children's assets

Gail Heinzman, CPA (Gail@HeinzmanGroup.com) responds to both Carol Arnott and Joyce Pearson (below).

The legal ownership of a 529 plan may be in the name of the child or the parent. As noted below, if the 529 account is an UGMA, it is the child’s property.

As to the comment by Joyce Pearson, that may apply in some cases but not all. A 529 plan may be an UTMA in which case it is an irrevocable gift. However, if the owner is the parent, he/she has the right to re-designate beneficiaries. This usually happens if an older child does not exhaust his/her 529 plan and younger child needs more money for education. In this case, the original designation was not an irrevocable gift. I have not seen a 529 with multiple owners or divided control. The terms of 529 plans vary. This issue should be addressed with their attorney.

Response to Carol Arnott's comments

The following is a response to Carol Arnott's comments on children's assets from Joyce Pearson, DivPlan@aol.com.

I would have a tendency to disagree with Carnott re: 529 Plans. My understanding is that they are an irrevocable gift to beneficiary (which is why they are out of the estate of the donor) but under the control of someone ( usually the grantor). Recognizing that even with an UTMA the 529 can be liquidated, I make sure that all parties are aware of the ease with which this can be done. So If possible they are divided for control purposes and ability to add future dollars to ensue educational goals are met but not considered part of the marital division/assets used for offset purposes.

More on Children's accounts

After my posting last week about children's accounts, Carol Arnott (carnott@greenvillefinancial.com) contacted me with further information:

"To be more specific, assets held in custodian accounts for a minor, such as an UGMA or UTMA, are not considered marital property since they were irrevocable gifts to the child when contributed to the account. A more popular way to save for college education in recent years, however, is the 529 college savings plan. Assets held in these types of plans are controlled by the owner of the account, typically the parent, and may be considered marital property subject to property division. In addition to favorable tax treatment for funds used to pay qualified higher education expenses, one of the key benefits of a 529 plan is that the child does not gain control of the funds when they reach the age of majority. An exception to this rule is if the funds in the 529 plan were transferred from a custodian account. If that’s the case the funds belong to the child and not the parent. Bottom line- look at the statements and ask questions!"

Children's accounts are not marital property

You may have accounts that you have earmarked for the children's education. They must be set aside and not divided as part of the marital property. They belong to the children.

Don't forget tax refunds

Sometimes, assets come in later, after the divorce is final -- such as tax refunds, bonuses on work done while still married, royalties, etc. Don't forget to include those in your settlement negotiations.

What about stock options?

Stock options are complicated and require a lot investigation into the type, the ability to divide or transfer, and the way to allocate the funds when they are dividied. Be sure to consult an expert on this asset.

The Biggest Problem With QDROs

According to Edwin Schilling III, JD, one of the most significant problems with QDROs is not having them prepared before the divorce is final. Mr. Schilling lectures attorneys on “The 30 Most Common Errors in QDROs.” (Qualified Domestic Relations Order)

The reason this is such an enormous problem is that after the divorce is final, the former spouse has no rights to something that was not legally addressed. If the participant spouse dies before the QDRO is prepared, the former spouse loses rights to share in the retirement plan. As he says in his program, “Once the marriage is over, if there is not an appropriate order in place, the former spouse has no more rights to the retirement and benefits than does my mother. The former spouse is a stranger to the plan without an order.”

Mr. Schilling says that he has had 13 cases when the participant spouse died before the QDRO was prepared and he had to explain to the non-member spouse that she/he may have lost everything. These cases usually result in malpractice claims against the attorney of record.

Mr. Schilling shares a couple of his worst stories. In the first one, his client was the wife who was married to a Federal Civil Service employee who was not entitled to Social Security. The spouses were in their 60’s and had been married 40 years They had agreed that she would half of his pension and survivor benefits worth more than $3,000 a month. The lawyer for the wife begged the judge to enter Mr. Schilling’s order at the time of the dissolution, but the judge refused and set a follow-up hearing date three months later to deal with property issues. The next week the husband died. How would you like to be the one to tell this lady that she will have no income and that the benefits of 35 years of federal employment were gone?

Decisions made by the Judge in divorce court

Do you ever wonder why we divorce professionals try to get our clients to settle rather than go to court and have the judge decide their future? Read the following regarding some surprising facts from the court files.

In the late 1980s, several states set up task forces to study gender bias in the courts. For example, in Colorado, one section of the task force was charged with the area of divorce. It studied cases taken directly from the court files. The parameters were that (1) the marriage have lasted 12 years or longer, (2) the case be decided by a judge as opposed to being settled out of court (the task force wanted to see the results of what the judges were doing), and (3) there was a minimum of $10,000 in positive net worth.

There were 28 cases in the year previous to the study that matched the above parameters. Out of 28 cases, the average length of marriage was 20.5 years. At the time of divorce, the average age of the wife was 44, the husband, 45. Eleven of the 28 families had net assets of less than $50,000 at the time of divorce and ten had net assets of $100,000 or more.

At the time of the court order, the wife’s average net worth was slightly greater than the husband’s, because she was usually given less of the marital debt. Within four years of the divorce, however, the wife’s projected net worth declined by 25 percent while the husband’s nearly doubled. Within eight years of the divorce, the wife will have a negative net worth while the husband’s projected net worth is approximately $200,000.

In gathering data, besides looking at the court files, the Colorado task force interviewed many divorced men and women. One women told her story about the alimony award after 38 years of marriage during which she was not employed. The judge ordered her husband to pay her $300 per month for two years. He awarded the house, appraised at $160,000, to the wife, and all the other assets, including a retirement fund, to the husband, saying, “Mother has been out of the work force, and if we gave her all that money she wouldn’t know how to handle it.”

Another woman told the Colorado task force that she had been awarded a tractor as part of the property settlement but her ex-husband refused to deliver it. She had tried for four years to get the original order enforced, without success. One district judge gave her former husband permission to continue using the tractor. When her lawyer objected, the judge asked her what she was going to do with the tractor.

The Washington State Task Force on Gender and Justice in the Courts found that only 10% of all wives being divorced were awarded alimony and the average amount was $432 per month for an average length of 2.6 years. The national average as of spring 1986 had 15 percent of wives receiving an average of $329 per month.

We have all seen improvements in the rulings from the bench but perhaps it is time to re-visit court files to see how much the numbers have changed.

Why I turned down Oprah!

It all stemmed from a highly publicized battle over career assets which made the cover of Fortune magazine in 1988. Lorna and Gary Wendt were married for 32 years. He was the CEO of GE Capital; she was the “corporate wife.” At the time of the divorce, he declared the marital estate to be worth $21 million and offered her $8 million as her share. She balked, saying that the estate was worth $100 million. Her counter to him was that she wanted $50 million or half.

Lorna Wendt’s position was that her husband’s future pension benefits and stock options had been earned during their marriage. She argued that her contribution as the homemaker and later, wife of the CEO, enabled him to rise through the ranks to the top of an international organization. Her husband didn’t agree.

In the early years of their marriage, she had worked to support them while he attended Harvard Business School. They moved often while she handled the details of the household and took care of him and their two children. When he became CEO, she was expected to entertain often and extravagantly as his position required. She felt she was a 50-50 partner in the marriage and the accumulation of all assets.

The Wendt case broke through the long-held belief that “enough is enough” – that a spouse deserved enough to maintain her lifestyle – nothing more. In a landmark decision, the judge awarded her $20 million – far less than the $50 million she had requested, but far more than the $8 million her husband initially offered.

Oprah’s staff called me and asked if I would take part in a debate on Oprah’s show between the positions “enough is enough” vs. “half.” They wanted me to take the position that “enough is enough” and I had to turn them down explaining that I believe in the 50/50 division of assets. Oh well!

10 Most Common Money Mistakes in Divorce

For a Free report "10 Most Common Money Mistakes in Divorce," go to www.DollarsAndCentsOfDivorce.com.

Health insurance after divorce

In the traditional marriage where the husband is the main wage earner, one concern is maintaining health insurance for the ex-wife after divorce.

It is not uncommon for women over 40 years of age to develop severe health problems. Some become almost uninsurable, at least at a reasonable cost. This is a real concern where, all of a sudden, they are on their own and responsible for acquiring health insurance.

The Older Women’s League (OWL) worked hard to get the Consolidated Omnibus Budget Reconciliation Act (COBRA) law passed in 1986. It allows women to continue to get health insurance from their ex-husband’s company if it has at least 20 employees, for three years after the divorce. The normal COBRA provision states that, if an employee is fired or leaves a job, he or she can get health insurance from that company for 18 months. However, in a divorce, it is extended to 3 years or 36 months.

Linda and Bob are getting divorced. Assume that Linda decides to continue health insurance under COBRA from Bob’s company. Linda must pay the premium as agreed. If she misses a premium payment, the health insurance company can drop her and they do not need to reinstate her. So, she must pay that premium on time. Typically, Linda will not get the discounted group rate but will be charged the full rate. It is important to shop for health insurance, even though the COBRA provision may supply a quick solution to health care coverage, it may not be the best. It may be purchased at a lesser cost somewhere else.

Linda should shop for health insurance because if she can match the rate from Bob's company or get a lower premium with another company, she should buy her own. Then if something happens, as long as she pays her premiums, she is covered. Otherwise, at the end of three years, COBRA drops her, and then she has to start shopping for her own insurance. By that time, she might be uninsurable and not able to find insurance at a decent cost.

Finding Hidden Assets in a Divorce

There are many ways that assets can be hidden in an impending divorce. Following are a few to be aware of:
1. Financial statements to acquire a loan: Any loans from lending institutions require sworn financial statements to be filled out. In most cases, the borrower is trying to impress the lending institution with the extent of assets and may exaggerate these. Looking at these statements may show valuations substantially greater than what is now claimed.

2. Deferred salary increase, uncollected bonus, or commissions: It is always a good idea to check with the spouse’s employer to determine whether a salary increase is overdue, when it will be forthcoming, and how much it is. Employers are sometimes sympathetic to their divorcing employees and willing to bend the rules slightly to defer salary increases, bonuses, or commissions in order to suppress apparent income.

3. Income tax refunds: It is possible to over-withhold taxes from earned income so that there will be a refund coming that noone knows about or has thought about! This is especially effective if the divorce is final before the refund comes in the mail. Then, the recipient of the refund doesn’t feel obligated to share that information or the refund.

4. Cash transaction: One spouse may be in work where cash is paid. Such cash payments are rarely reported on the income-tax return, but if you know of such income in the past and can subpoena current information, it will help in proving available income in excess of that shown on the income-tax returns.

5. Children’s bank accounts: Frequently, a spouse who wishes to hide money will open a custodial account in the name of a child. Deposits and withdrawals are made without any intent that the child has use of the account except in case of the spouse’s death.

6. Phony income-tax returns: When the divorce has been filed, some spouses are inclined to alter the copies of their previously filed income-tax returns to hide or adjust pertinent financial information. If you have reason to believe that furnished copies have been altered, ask for copies of jointly filed returns directly from Internal Revenue Service.

7. Phony loans or debts: To keep cash from being divided, a spouse may sometimes attempt to bury the money with a phony loan to a cooperative friend or relative. The loan may be tied up with a long-term note so as to remove this money from consideration at settlement time.

8. “Friends” or other phonies on the payroll: If one spouse is in a position to control the payroll of a sole proprietorship, partnership, or closely held corporation, he or she may be paying salaries to a friend or relative who is not actually providing services commensurate with the compensation.

More on TIPS

Many of the TIPS on this blog are taken from the books "Survival Manual for Women in Divorce" and "Survival Manual for Men in Divorce." You may find these books at www.FDAdivorce.com.

How divorce affects Social Security benefits

If a couple has been married for 10 years or longer and they get divorced, the wife is entitled to half the husband’s Social Security provided certain provisions are met.

Since this rule does not diminish the amount the husband receives at retirement, he usually doesn’t worry about this.

Assume the husband will get $750 a month when he retires. If they have been married 10 years or longer, she would be able to get $375 (one-half of the husband’s benefit) at age 65.

What if he gets remarried? If he is married to his second wife for 10 years and they get divorced, Wife #2 gets $375, Wife #1 gets $375, and he still gets $750. His limit is four wives! As long as he is married to each one for 10 years or longer, they each get half of his Social Security benefit.

What if the wife gets remarried? If she is married at retirement time, she looks to her current husband for her benefit. But if she has been married to Husband #2 for 10 years and they get divorced, she is entitled to half of Husband #1’s benefits or half of Husband #2 benefits or her own, whichever is higher. She has a choice.

What if they get divorced and he dies? The ex-wife is entitled to widow’s benefits.

A widow’s remarriage after age 60 will not prevent her from being entitled to widow’s benefits on her prior deceased husband’s earnings.

Example: Assume that Maude’s first husband died. At age 58, she met a wonderful widower and wanted to get remarried but she realized that she would lose her entitlement to all of the deceased spouse’s Social Security benefits when she turned age 60. This may explain why many senior citizens are living together unmarried until after age 60.

Don't violate the Child Contingency Rule!

If any amount of alimony specified in the divorce decree is reduced upon the happening of any contingency related to the child, then the amount of the reduction will be treated as child support, rather than alimony, from the start.

The following example shows what many attorneys have incorrectly advised their clients to do.

Example: Kevin and Karen are getting divorced and their son, Josh, is going to live with Karen. Kevin is going to pay Karen $3,000 per month maintenance plus child support. Kevin’s attorney says, “Since Josh is graduating in 5 years, why don’t you pay Karen maintenance of $3,000 a month for 5 years and then reduce it to $2,000 a month for an extra 3 years. Karen won’t have as great a need when Josh leaves home.”

This is creating a serious tax problem for Kevin. The IRS may consider the reduction of $1,000 a month to be child support because it coincides with a child contingency. The IRS will then go after Kevin to collect the taxes he saved by calling it maintenance and they will make it retroactive from the beginning. Five years (60 months) times $1,000 is $72,000 that he will have to pay tax recapture on!

What is a contingency? A contingency relates to a child if it is dependent on an event relating to the child, regardless of whether the event is likely to occur. Some examples are:
- Reaches age 18, 21 or the age of majority in their state
- Gets married
- Graduates from school
- Leaves home
- Joins the military
- Gets a full-time job

Again, if the final divorce order says that alimony reduces or stops upon the event of any of the above contingencies, that will trigger the recapture of taxes.

Don't get stuck with capital gains taxes

After being involved with over 600 divorce cases, I find that the one question most overlooked by attorneys is, What is the basis in the house (or stocks, other real estate, or other investments in the couple’s portfolio)? Consider the following case study.

Melanie and Mac have been married for 18 years. They have no children. They have decided everything except how to divide the remaining three assets equally. Those assets are a cottage in Hawaii worth $350,000, an IRA worth $150,000 and a savings account worth $250,000. The $250,000 in the savings account represents a loan taken against the cottage in Hawaii.

Mac proposed to Melanie that she take the cottage and sell it. She would net $100,000. And she should also take the IRA worth $150,000. He would take the savings account and they would each end up with $250,000.

Melanie talked this over with her attorney and they thought that this sounded fair. But, we find that the one question most overlooked by attorneys is, “What is the basis?”

What Melanie’s attorney should have asked Mac would have revealed that Mac had paid $90,000 for the cottage 15 years earlier. It was sold at an incredible estate sale. There was a $260,000 capital gain, which created a tax of $52,000 (capital gains tax at 15% plus state tax at 5%).

As this was not their principle residence, they did have to pay the capital gains taxes. There is no exclusion on property that is not the principle residence.

Melanie received $100,000 and had to pay out $52,000, so she had only $48,000 left.
The after-tax value of the IRA is approximately $100,000 (not counting penalties as she is not planning to liquidate it immediately), so Melanie ends up with $148,000. The $250,000 that Mac borrowed from the cabin and put in the savings account was his, tax-free and clear.

He ends up with $250,000 and she ends up with $148,000, because the question was not asked about the basis. Do you think Melanie’s attorney had some liability here? Absolutely!

Be sure to investigate the basis in all assets. Then there will be no surprises.

Divorcing couple can save up to $50,000 in home sale

Sophia and Lars had a 12 year old son who was going to live with Sophia in the family home after the divorce. The home had a capital gain of $984,000. They agreed that Sophia would sell the family home in 6 years when the son graduated from school. Lars stayed on the deed and their agreement was stated in their divorce decree. Even though Lars left the family home, he was able to satisfy the Ownership period and Sophia's continued residence in the house satisfies the Use test for Lars. After leaving the house, by staying on the deed, he was able to satisfy the Ownership period. When the house was sold, both Sophia and Lars were able to take a $250,000 exclusion for a total of $500,000.

This exclusion is allowed every two years. Lars could have bought his own house, sold it in two years, taken up to a $250,000 exclusion on it and still be able to take the $250,000 exclusion on the family home. It will work as long as each sale is at least two years apart.

Even if Sophia and Lars both get remarried to other partners, as long as Lars stays on the deed he can still take up to a $250,000 exclusion. Let's say that Sophia got married to Peter and Peter moved into her house. At the time of the sale, Peter would have also fulfilled the two year requirement for the Use period and he could use Sophia's Ownership period because of being married to her. So, according to the IRS, he could also take a $250,000 exclusion!

If Lars gets married to another partner, she is not entitled to take a $250,000 exclusion because she did not use the residence as her principal residence.

The savings of $50,000 comes from calculating 15% federal capital gains tax plus 5% state tax (in some states) for a total of 20% tax savings on $250,000 equals $50,000.

Get money from a 401k with no penalty

Karen's divorce decree awarded her $300,000 from her husband's 401k. She could transfer the money to an IRA and pay no taxes on this amount until she withdraws funds from the IRA. But Karen needed $80,000 to pay off credit cards and other debt. Because the 401k plan withholds 20% to pay taxes, she needed to ask for $100,000.

The 401k plan withheld $20,000, sent Karen $80,000 and transferred the remaining $200,000 to her IRA. The IRS says that any money received from a qualified plan, such as an 401k, in a divorce situation only, can be spent without penalty, even if the recipient is under age 59-1/2.

Karen does have to pay the taxes on the entire amount of $100,000 but she did not have to pay the 10% early withdrawal penalty. There are specific guidelines in accomplishing this without having to pay the 10% penalty so a divorcing person needs to seek the guidance of a financial professional.

After the money from a pension plan goes into an IRA, which is not considered to be a qualified plan, Karen is held to the early withdrawal rule. If she says, “Oh I forgot, I need another $5,000 to buy a car,” it is too late. She will have to pay the 10% penalty and the taxes on the moneys taken out of the IRA.

Life insurance to cover alimony

Alimony stops upon the death of the payor. So it is extremely important to protect that stream of income with life insurance on the payor's life. It is also important to consider having the beneficiary be the owner of the policy.

Don't cancel insurance too soon

If all your cars are on one insurance policy and your car's insurance is cancelled because your spouse figures you will get your own, you are without insurance until you do get your own.

Suppose you are the beneficiary of your spouse's life insurance and it is cancelled. Two things may happen: (1) Your spouse may die before the divorce is final and there are no proceeds or (2) The court orders your spouse to carry insurance to cover alimony (see above paragraph) and now the spouse is older and to get new insurance will be much more costly.

Use of a QDRO

This stands for Qualified Domestic Relations Order. It is the legal document that is sent to the plan administrator which tells the administrator how much money from the retirement plan to send to the ex-spouse. It is the only way for the ex-spouse to get payout from a qualified plan such as a 401k. It is typically drawn up by your attorney or a specialist who drafts QDROs.

Some problems with QDROs

If your Qualified Domestic Relations Order is not properly drafted, you may be the loser.

What if your spouse dies after you start receiving your portion of the benefit? Will your portion continue to come to you?

What if your spouse dies before the benefit starts? Will you still get the portion you were entitled to?

What if your spouse takes early retirement with a large buyout package? Does your QDRO say you are entitled to a portion of it?

What if you are to receive half your spouse's 401k but before it is divided the market goes up sharply? Are you entitled to half the increase?

These are some of the many issues that are sometimes ignored when the QDRO is drafted. Be sure to talk to your attorney about these issues.

Don't pay the 10% penalty

There is a way to escape paying the 10% penalty when you have to withdraw cash from a qualified retirement plan such as a 401k before you are age 59 1/2. It has to be done before the money is transferred out of the 401k. (More on this subject next time!)

Value of household goods

Household goods are valued at garage sale value. that means all furniture, pots and pans, sheets, etc. The exceptions would be: antiques, art collections, etc. They may need to be appraised if you feel there is greater value to them. Autos are typically valued by the Blue Book value.

Use of property settlement note

Sometimes there isn't enough cash or other assets to 'buy out' the other spouse. One example would be the family business. In that case, you could do a property settlement note or equalization payment. It is like a note at the bank - you determine the number of months, amount of payment, interest rate, etc. These payments are considered a division of property and therefore are not taxable to the person receiving them, nor deductible by the person paying them.

Appraise family business

The family business is more complicated. It is sometimes difficult and costly, to appraise a business. But it is necessary. So, get out of that poverty mentality, and hire the experts who will help provide the best information for you to make an informed decision about your final settlement.

Capital gain on the house

The 1997 revised tax law says we can no longer roll over capital gain in the family home. The one-time exclusion of $125,000 is also gone. Instead, we have something even better. Now, each spouse can take up to $250,000 exclusion if they have lived in the house two of the past five years.

If your house has a very large capital gain, you should consult with a CPA or a financial divorce specialist to see how to handle this the best way. It is possible for both spouses to take the $250,000 exclusion for a total of $500,000 if it is handled properly.

Find out the basis in your home

If you receive the family home that has a low basis, you may be liable for capital gains taxes later. This would also apply to stock accounts and other real estate. Basis does not relate to the amount of the mortgage. It relates to the amount originally invested in the property adjusted by improvements, sales costs, etc.

Get real estate appraised

You may agree on the value of your home, but what if you receive the home and you agreed it was worth $360,000 but when you go to sell it, you can only get $250,000 for it? That means you may have left more than $55,000 on the settlement table! (One half of the difference of $110,000.)

Property settlement is a done deal

After the divorce is final, if you change your mind about how something was divided, or which property you got, it is too late to change it. The only exceptions would be if you found additional property that was not disclosed or if you feel fraud was involved.

Know the difference between separate and marital property

Separate property is everything you bring into the marrige and keep in your own name. It is also what you receive during the marriage as a gift or an inheritance.

Marital property is everything acquired during the marriage - no mattter whose name it is in. And in some states, but not all states, the increase in the value of separate property.

For instance, consider a $20,000 savings account brought into the marriage which earned $3,000 during the marriage and is now worth $23,000. The $20,000 would be set aside as separate property and the $3,000 would be included in the pot of marital assets to be divided.

Assume the wife adds $100 each month to her IRA which is in her name only. That is still considered to be a marital asset because it is "everything acquired during the marriage, no matter whose name it is in."

Consider cost of living increases for child support

We all know that children seem to get more expensive as they get older. They seem to have more expensive 'toys' such as computers, skis, orthodontics, etc. Many couples discuss including a cost of living increase each year for child support.

Child Support Guidelines

All states now have Child Support Guidelines. They are usually based on the incomes of both parents and the amount of time the children spend with each parent. As each state may vary widely in its calculations, consult with an expert in your state.

Child support is always modifiable

We discussed how alimony may or may not be modifiable. Well, child support is always modifiable. The courts will not allow us to take away the rights of the children.