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Divorce can bring inequities affecting assets, liquidity

Divorce attorneys say that they see a dramatic uptick in business following the holiday season. After unhappy couples grit it out in December, they take a couple of months to move into action mode. That’s why divorce filings spike in March.

Dissolving a marriage is a wrenching emotional experience for everyone involved, but it also takes a financial toll. The household is separated, resulting in two rents or mortgages; utility bills double, and there’s no way to save on bulk purchases. Living expenses for each member of the couple are likely to increase, while combined income stays the same.

How assets are divided varies by state. If you live in a “community property” state such as Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin, any assets acquired during your marriage will be split 50-50 in divorce.

In non-community property states, “equitable distribution” laws govern the division of a couple’s assets. Some states divide only assets acquired during the marriage while others consider everything available for divvying up. But marital assets aren’t necessarily divided equally. In some states the distribution laws take on a punitive aspect by considering which partner seems most at fault for the breakup.

Regardless of the actual split, it is important to be careful about maintaining liquidity after a divorce. Although there may be a great desire to hang on to the family house, especially when there are children involved, if one spouse gets the house but not enough liquidity or income to maintain it, there could be a problem down the line. The math of the divorce settlement may show an equal split, but one of the spouses could be stuck with an illiquid asset that could be tough to dispose of if cash flow becomes an issue.

Divorce can also create tax implications for the couple. While the splitting of retirement accounts through a “QDRO,” a qualified domestic relations order (dol.gov/ebsa/faqs/faq_qdro.html), does not result in a tax event, the sale of assets in a taxable account or a home with lots of accumulated gains could amount to a big tax bill. It’s important to factor in the net amount that each person will receive, as each member of the couple builds his or her new financial plan.

In terms of income, when one spouse earns significantly more than the other, he or she may have to provide alimony. After a short marriage, the alimony is likely to be temporary (say, for two to five years). Payment of alimony is tax deductible, while receipt of alimony is considered ordinary income. The spouse receiving alimony must factor in whether it has an end date and how that will affect income.

Child support is usually determined by each state’s specific formula, though courts can award more if they choose. Agreements can be adjusted, due to changes in parents’ income. If you are to receive child support, make sure that the paying spouse purchases a life insurance policy covering the term of the payments, naming you as the owner and beneficiary of the policy.

Finally, I am often asked about mediation, which can be a faster and less expensive way to arrive at an agreement. Even if you engage a mediator, you should have a lawyer review the agreement to make sure you haven’t overlooked something. Adding a qualified CPA experienced in divorces or a certified divorce financial analyst may also help you create a plan that is mutually agreeable.

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