Divorce mediation can be a less contentious and often more affordable way to navigate the end of a marriage. When it comes to the financial aspects of divorce, particularly concerning taxes, mediation offers a unique opportunity to make informed decisions together. Understanding the tax implications of various assets and settlement choices during mediation can save both parties significant money and hassle.
In a traditional litigated divorce, decisions are often made by a judge who may not prioritize tax efficiency. In divorce mediation, you and your spouse, with the guidance of a neutral divorce mediator, and potentially tax professionals, can actively shape the settlement in several areas to optimize tax outcomes for both of you. It is best to keep the most amount of money in your pockets by making smart financial tax decisions and out of Uncle Sam’s coffers.
Spousal support (alimony) can be a hot button topic in a divorce and needs to be addressed delicately and factually. The federal tax rules around spousal support have changed significantly. For divorce agreements finalized after December 31, 2018, at the federal level, alimony payments are not deductible for the payer and not taxable to the recipient. At the New Jersey level, payers still deduct alimony, and recipients report it as taxable income. This clarity can help in negotiating the amount and duration of payments. Due to these tax changes, overall alimony amounts are typically lower now than prior to 2018. This is important to understand because one client may be angry that their divorced neighbor is getting a much higher amount of spousal support (but is paying taxes on that amount) than you may be receiving (as non-taxable income).
Unlike spousal support, child support payments are neither deductible by the payer nor considered taxable income for the recipient at a federal and state level, regardless of when the agreement was finalized. During mediation, clearly distinguishing between alimony and child support is important for tax purposes. Sometimes, parties might be tempted to label spousal support as child support or vice versa, but this can lead to issues with the IRS if not properly structured and documented. And you want to clarify when each type of support will end.
The division of marital assets and property is where tax planning can truly shine in mediation. When a qualified retirement account (401(k), IRA) is divided, paperwork needs to be completed to finalize the transfer of funds. A Qualified Domestic Relations Order (QDRO) is typically used for 401(k)s and similar employer-sponsored plans. This allows for a tax-free transfer of funds to an ex-spouse, who can then roll it into their own retirement account without immediate tax penalties. Without a QDRO, early withdrawal penalties and income taxes could apply. For IRAs, a direct transfer between spouses is generally tax-free. A divorce mediator will ensure the proper steps are spelled out in your divorce agreement. These transfers need to be executed correctly to avoid unintended tax consequences.
Dividing investment accounts and other taxable accounts involves considering the “cost basis” of the assets. The cost basis is the original value of an asset for tax purposes. If one spouse receives assets with a low-cost basis, they might face a larger capital gains tax when they eventually sell them. Conversely, assets with a high-cost basis or even losses can be more tax-advantageous. Divorce mediation provides a forum to discuss these values and try to distribute assets in a way that balances potential future tax liabilities, perhaps by offsetting lower-basis assets with other considerations.
Typically, one of the most valuable marital assets is the marital home. If you are selling the marital home then there are timing and tax consequences to consider. The capital gains tax can vary. Gains up to $250,000 for a single person (or $500,000 for married filing jointly) can be excluded from capital gains tax if certain conditions are met regarding ownership and residency. In divorce mediation, you can strategize who is doing the selling and when this will occur. You may want to consider selling the home before the divorce is final to take advantage of the higher joint exclusion or structure the agreement so the spouse keeping the home understands their individual exclusion limit.
For parents, determining who claims the children as dependents for tax purposes and who receives the child tax credit can have an impact on tax liability. Typically, the custodial parent (the one with whom the child lives for the majority of the year) claims the child. However, parents can agree in divorce mediation to alternate years or for the non-custodial parent to claim the child. This can be an important point, especially if one parent benefits more from the credits due to their income level.
While a divorce mediator is a neutral facilitator, they are generally not tax experts. That is why a divorce mediator at Westfield Mediation always recommends to run your divorce agreement by a tax professional before it is finalized. Both parties should consult with their own tax advisor or a Certified Divorce Financial Analyst (CDFA) during the mediation process. These professionals can provide personalized advice on the tax implications of proposed settlement options, helping you make truly informed decisions that optimize your financial future post-divorce.
By addressing taxes proactively within divorce mediation, you are not just dividing assets; you are strategizing for a more stable and predictable financial transition into your separate lives.
