Financial Considerations in a Collaborative Divorce

 
Last week I ran into an acquaintance who is in the process of getting a divorce. She tells me things are going smoothly; it is a collaborative divorce with no attorneys involved.  Both she and her spouse are going out of their way to be civil towards each other for their children – a 12 and 14 year old.  They are also amicably splitting their assets and will have joint custody.

The accountant in me had to say, “Don’t forget to discuss which parent gets to deduct the children on future income tax returns.”

She responded with “I never thought of that.” and “How do you know that?”

I’ve worked in some aspect of accounting for almost 30 years and have my CPA license, but to be honest, most of what I’ve learned about the financial pitfalls of divorce comes from co-workers and friends complaining after things have gone badly.

Here are a few tips:

Claiming your children as dependents:

Usually the parent who has custody of the children for the greater part of the year will claim them as dependent exemptions on their income tax return. This is an important designation because most often the parent who can claim their children as deductions is also the parent who receives other tax related benefits and credits.

Head of Household

This filing status is only available to the custodial parent. It provides a bigger standard deduction and looser tax tables than single taxpayer status.

Higher education costs:

The spouse that claims the children as a dependent is the parent allowed to claim the American Opportunity Lifetime Learning Credit (this can be worth up to $2,400 during the first four years of a child’s education). If you do not claim your children as dependents you can’t claim this credit even if you were the parent paying their college bills.

Get it in writing:

In joint custody situations parents can take turns claiming the children, but this has to be in writing. Make sure it is part of the divorce agreement.  If the non-custodial parent wishes to claim the child, the custodial parent must waive their right to claim the child on IRS form 8332.

Don’t assume you are entitled to the exemption because you pay child-support:

A newly married co-worker filed a joint tax return with her new husband claiming his daughter from a previous relationship as a dependent. (She thought the first parent to file gets the exemption).  The child’s mother also claimed the child despite being told my-coworker had claimed her.  His return was audited, the IRS deemed the mother as the custodial parent and eligible for the deduction.  My co-worker and her new husband had to pay back taxes were fined and required to pay interest on their return.

Alimony:

Alimony is considered taxable income for the recipient.  If you receive alimony make sure you make estimated payments or set aside a portion of each check so you are prepared for your tax bill the following year.

Alimony payments are deductible by the person paying them, but only if made on account of a divorce decree or written agreement. An oral agreement will not suffice and payment must be in the form of check, cash or money order.   

Retirement savings:

401(k) distributions are taxable.  If you want your spouse to be responsible for taxes on distributions they receive from your retirement account make sure your divorce papers include a (QDRO) qualified domestic relations order. Without a QDRO, you may end up paying the tax bill.

Spouses do hide money:

This is probably the biggest lesson I can give you.  During my 30 years of working in accounting departments I have been asked more than once to not pay a commission, bonus or to withhold a raise until after an employee’s divorce is final.  I’ve seen this at more than one company and the request is always granted – it is the employee’s money.

I’m not familiar with how collaborative divorces work, if lawyers are not involved I recommend consulting with one anyway to make sure all interests are covered.  Consulting with a tax accountant can’t hurt either.

Are you aware of financial pitfalls in a collaborative divorce?