David Long, CPA, CVA is a director at Corrigan Krause.
Going through a divorce can be financially draining if you do not have the right team supporting your financial decisions. Settling a divorce agreement requires more than an attorney, especially if your wealth is at stake. Consulting with a public accountant is critical in steering your financial decisions in the right direction. So how can a CPA assist clients going through a divorce?
Understanding current tax law issues
It is important to understand the changes created by the Tax Cuts and Jobs Act (TCJA) affecting divorce. Beginning after December 31, 2018, payments are no longer deductible under divorce or separation agreements. In addition, these payments are no longer taxable to the recipients.
Example of rules before 2019: $50,000 of alimony before 2019 would have cost the payer approximately $35,000 (net after estimated 30% federal and state tax savings) due to the tax benefit for the deduction claimed. The recipient would have received taxable alimony of $50,000, net after tax of $35,000. Under the old law, a $50,000 payment was actually costing the payer $35,000 and the recipient was actually receiving $35,000.
Example of rules after 2019: $50,000 of alimony post-2018 will cost the payer about $70,000. They will pay $20,000 of income tax and then remit $50,000 to the recipient tax-free. That’s quite a swing to both sides of the divorce. It is my understanding the courts have modified their divorce tables but this should be reviewed on a case by case basis.
Are all assets the same when splitting them?
Getting a divorce can be difficult, but the addition of selling, splitting and dividing business assets can make the process even trickier. Certain assets are easier to separate than others. Cash, stocks, liquid assets are usually easy to split. But what about non-liquid assets?
Would you rather have the house with $200,000 of equity or the IRA account with $200,000 of value? Are they both worth $200,000 today? You can sell the house today and generate $200,000 of cash. The IRA is worth only $100,000 in after-tax dollars after applying a tax rate and 10% penalty (assuming a 40% tax rate). Give me the house every time in this example.
But what if you and your spouse have ownership and interest in a business? When a closely held business is involved, a business valuation is typically required to determine the equitable distribution of marital assets. A business valuation is critical to protecting the rights to the wealth accumulated during the marriage and is a critical step in completing the property settlement phase in a divorce. Another option both parties might also consider is hiring a joint expert valuator. This will help with disputes and reduce valuation fees.
It is also important to understand the “double dip” effect and coach the attorneys on this concept. The “double dip” is when the business asset is valued and the business owner’s compensation is also being used to calculate support. It occurs when in the business valuation the owners’ compensation is adjusted to a reasonable level (usually downward). This increases the value of the business. However, the courts may still use the higher actual compensation to calculate support. I guess if your side is receiving the “double dip” then 2 scoops are better than 1!
How do we get the value out of the business?
Business value distribution can be complex. To help better understand the complexities, we have created a list of three methods divorced couples can use when planning how to distribute these assets.
A ‘buy out’ is the most common method used and occurs when one spouse buys the other’s interest in the business. Typically, this situation only works if the buying spouse has enough cash to pay the selling spouse. The transfer of cash can be made through several types of transactions: a one-time lump sum; structured buyouts over time, or through an offset of marital liquid assets.
Another way to distribute business assets is to continue to run the business jointly after the divorce. However, co-ownership requires the relationship to be amicable where both parties can continue to trust and respect one another. Another version of co-ownership occurs when one spouse continues to operate the business while the other agrees to accept profit payments from the business.
Sell the Business
The final method to ensure each spouse receives value for their interest in a business is to sell the business and divide the proceeds. This is also a common way to distribute other types of properties as well. Similar to the others, this method poses some difficulties. It takes time to find a buyer. There is business risk the longer it takes to sell the business. It also creates complications if each spouse disagrees over the value of the business.
While a divorce may be complicated, hiring an accountant to the divorce team will help ensure the client and attorney clearly understands the value of each marital asset and the options available to monetize these assets.