Married people save money by sharing household expenses. But when divorce strikes, the couple’s bills may suddenly double. You need to pay two electric bills, two mortgages and (hopefully) two vacations — often from the same income base. Many people worry that getting divorced will lower their standard of living or that their former spouses will “take them to the cleaners.”
These worries are often justified. Millions of dollars could be at stake for complex, high-value marital estates. Here are five commonly asked questions about protecting financial interests in divorce. The answers might give you awareness and peace of mind during your divorce proceedings.
What’s included in the marital estate?
Not every asset that you or your spouse owns is part of your marital estate and, therefore, divisible when you get divorced. What’s included in your marital estate is a function of many factors, such as:
- Prenuptial agreements;
A comparison between the asset’s acquisition date and your wedding anniversary;
- Each spouse’s contribution to the asset or participation in the asset’s management during the marriage;
- State laws and legal precedent; and
Whether the asset has been combined with other marital assets.
For instance, a piece of real estate acquired prior to your wedding may be specifically excluded from your marital estate if you signed a prenuptial agreement. But it will likely be included in your marital estate if you used marital funds to pay for landscaping and improvements on the property for the past ten years.
When it comes to business interests, the value to include in the marital estate can be even trickier. Only the appreciation in value during your marriage may be included if a spouse owned the interest prior to the marriage, for example. But if you contributed additional capital from your joint checking account, a court might rule that the entire business interest should be included in your marital estate.
In addition, goodwill may require special treatment. About half the states specifically exclude personal goodwill — the value inextricably tied to the owner as an individual — from the marital estate if alimony is awarded. The rest of the states either include or exclude all goodwill in the marital estate. When little relevant case law exists about how to handle goodwill in your state, courts sometimes look to other states for guidance.
What your marital estate includes (or excludes) varies from state to state, so pick your venue carefully if you have options. To illustrate, one wife moved across state lines with her children to the couple’s vacation home to establish residency in a jurisdiction that favors her financial interests and custodial rights.
- Prenuptial agreements;
Could my ex be hiding assets?
When divorce turns ugly, people worry that an estranged spouse will hide assets. A classic example is the cheating husband who buys real estate and jewelry for his mistress using marital funds. But male or female, rich or poor, self preservation may cause normally honest people to hoard assets. So, always be on the defensive.
If an asset goes missing or the numbers don’t add up, hire a forensic accountant. He or she can do a title search for undisclosed assets under your ex’s social security number. Forensic accountants also can evaluate income and expenses to determine whether everything appears legitimate.
What’s the real value of each asset?
Cash is king. You know what cash is worth, and you can spend it immediately. But what about your house, jewelry, retirement funds or business interests? The value of these assets is more subjective and less liquid.
Consider your house. Many people want to continue living in their home after the divorce, especially if they have children. But moving — and letting go of your emotional ties — may be better for your financial well being. The current real estate market is uncertain, and you risk having your property over-appraised. Plus if times get tough and you need cash, you may not be able to sell your house and downsize quickly. And banks are stingier about home equity lines of credit these days. A lump sum in cash might be a safer bet than real estate.
Retirement funds and private business interests are even harder to convert into cash. You generally cannot access your retirement until age 59 and 1/2 without incurring a 10% penalty. If you are currently, say, 40 years old, this can be a long time to wait.
Business interests may be subject to transfer restrictions or built-in capital gains tax. Suppose you own an interest in an S corporation; you are personally responsible for the company’s tax obligation, even if you receive no cash distributions to fund your tax bill. Plus it takes time and effort required to sell private shares, especially when you receive a minority interest.
The bottom line: Not all assets are equally desirable when settling your divorce. Consider the risk, liquidity and tax consequences of the asset mix you take away from the marital estate.
How much maintenance will be awarded?
There are two types of maintenance payments awarded in divorce cases: child support and alimony. Child support is an amount paid to the custodial parent to raise a minor child. It is usually based on a statutory percentage of the noncustodial parent’s annual income.
For income tax purposes, the noncustodial parent cannot deduct child support payments, and the custodial parent does not claim child support as income. Your settlement agreement should also specify who can claim dependency exemptions and tax credits for minor children, as well as who pays for college and health insurance.
Alimony payments are not a sure win. They are affected by many factors, including:
- Prenuptial agreements,
- Length of your marriage,
- Your status and standard of living, and
- Education, skills and earning capacities of both spouses.
The spouse who pays alimony can usually deduct it from adjusted gross income. If so, the recipient must claim alimony as taxable income. Alimony may be temporary until the non-monied spouse receives some training or education. Or it can last indefinitely until the non-monied spouse remarries.
All maintenance is based on the payer’s income, so reasonable replacement compensation is important to assess. If an unscrupulous person intentionally underpays himself or herself, court-awarded maintenance payments may be inequitable or insufficient to cover post-divorce expenses.
Will I have enough money to pay all my post-divorce expenses?
Financial independence can be scary. Some people getting a divorce have never held a job, paid a bill or individually met with a CPA in their lives. Others are uncertain how to invest the cash they’ve been awarded. Budgeting is a step in the right direction.
Creating a monthly household budget starts by brainstorming all sources of cash from alimony and child support receipts, salaries, investment income and gifts. Then estimate all your expenses, such as child support and alimony payments, household and vehicle costs, vacations, child care and health-related costs. As long as your income outpaces your expenses every month, you’re in good shape. If not, you should have sufficient savings available for any shortfalls.
The most important step in the budgeting process is comparing the budget to your actual income and expenses. This comparison tells whether your budget is complete and accurate. It also lets you know whether your spending is out of control. If you can’t get a handle on your finances, your financial advisor can help.
An Ounce of Prevention
Even the most amicable situation can turn adversarial if one party suddenly becomes greedy or suspects foul play. The best way to protect your financial interests is to communicate openly and freely share financial information with your former spouse.
Before you file for divorce — or as soon as you are served divorce papers — go through your financial records and make copies of relevant documents, such as:
- Bank, investment and retirement account statements;
- Mortgages and lines of credit;
- Personal tax returns;
- Home appraisals and closing documents;
- Legal contracts, such as shareholder agreements, leases and employment contracts; and
- Corporate financial statements and tax returns, if applicable.
- Personal and corporate loan applications can also provide valuable insight, because they include a personal balance sheet, which details all the assets and liabilities in your marital estate. Also check any safety deposit boxes and inventory their contents as soon as possible.
When in doubt, make a copy of documents and give them to your lawyer. If you don’t have access to your financial records, ask for specific documents during the discovery phase of your divorce.