It is August 2021. I begin talking about tax planning this time of the year with every family court client. But the April tax filing deadline is months away, right? Yes, but strategizing and planning now for possible future tax issues while maximizing refunds and minimizing an unexpected tax bill helps avoid nasty and costly tax issues in years to come.
While every case is unique, below is a breakdown of the non-exhaustive general issues we discuss:
1. Work with an accountant
Family law attorneys are neither accountants nor tax experts so having an accountant who knows federal and state tax Codes to discuss the pros and cons of financial settlements is sound financial planning. An accountant for self-employed folks is an absolute must.
2. Get caught up on missed tax return filing deadlines
Not everyone who is required to file a tax return does, and there are a variety of reasons why they still need to file two or three years of tax returns. Divorce cases, in particular, need all past federal and state tax returns filed with the IRS and state in order to determine if there is any tax liability or refunds for those missed years because the couple must now tackle how to divide anticipated tax liability or refunds. Waiting to do this after a divorce likely means more interest and penalties owed. Litigating post-divorce what to do with the prior tax liability or refunds gets very expensive very quickly.
3. Strategize the year in which to divorce
One’s marital or single status on December 31 of any year directly impacts whether a joint or single tax return must be filed. Looking at the parties’ historical tax refunds or liabilities on December 31 directly influences whether or not to divorce this year or next. It may be that the parties should divorce this year rather than next year so they together get a larger refund. However, divorcing this year may be better tax-wise because they pay fewer taxes filing their own individual tax return. Mortgage interest, daycare costs, and student loan interest are a few events that can help skew divorcing in one year versus the other. The accountant helps project the best tax consequences for filing married joint versus individually.
4. Possible federal and state tax changes
Congress and the state legislature frequently tinker with the tax code. The tinkering could be just talk and news stories with no tax changes. Or tax legislation is expected to be passed in a few months. Keeping in mind possible or likely tax changes and how those changes could help or hurt clients now and into the future is smart tax planning.
5. Figure out claiming the children for taxes
Family court Orders involving children need to clearly explain in which tax year a parent claims a child. If this issue was not addressed in a prior court Order, it should be addressed now. The IRS flags both parent’s tax returns if they both individually claim the child for taxes. The IRS then sends a letter to the parents advising them their returns and refunds, if any, are frozen until they figure out which one of them is claiming their child. Resolving this issue now versus having to go to court in the spring and possibly waiting months for a judge to decide how the parents must claim their child for taxes is well worth doing now.
6. Real estate taxes
Most divorcing couples agree that one of them is going to keep the primary home, second home, or investment property and refinance a mortgage. Divorcing couples who agree or are court-ordered to sell real estate or do a property transfer best consult with an accountant to weigh and measure the tax consequences the divorce has on the sale and possible tax consequences. It can be where selling real estate during a marriage can create a more valuable tax deduction or exemption.
7. Maximize investments
There can be tax consequences with dividing retirement accounts especially taxable investment accounts and stock sale or division. Selling certain investments can cause sizeable tax consequences. For example, rather than selling 100 shares of stock, it may make better tax sense to divide the shares between the parties to maximize cost basis or the purchase price of each stock. The tax Code for investments is complicated so having an accountant with whom to advise is incredibly important.
Rather than being an exhaustive “to-do” list, this list is a starting point for maximizing money. After all, most people want to keep as much of their earnings and investments for their family and themselves. Planning ahead now allows clients to experience less stressful tax seasons in Aprils to come.
If you would like more information about a family court matter, contact us at 218.722-2655 or fill out our consultation form to schedule a consultation.