DIY Divorce Pitfalls: What To Avoid (Part 3)

Having looked at the first four items on our list of things you should avoid if you’re going to pursue a Do-It-Yourself divorce, we wrap up this series with the last two concerns, namely the unintended tax consequences of DIY divorces. It is important to understand long versus short term asset values.

5. Understanding The Tax Consequences

Taxes are scary for a lot of people, and divorce certainly doesn’t change that fact. In fact, if not handled properly, taxes can become even scarier after divorce. Especially if you didn’t handle the tax related aspects of your divorce the right way. The tax consequences in the Internal Revenue Code relating to divorce can have a lasting negative impact on your finances. There are so many pitfalls for the unwary.  Typically, the IRS is not your best friend. If you don’t file all of the necessary documentation properly it will probably cost you. Many people fail to do that. As they say, the devil is in the details.

Issues like the liquidation of marital property and retirement accounts or transfers of real estate or investment accounts, or even timing of your divorce filing can have a significant impact on your future tax liability. Not filing properly or not understanding the nature of certain aspects of tax code will end up costing you big time! It is not uncommon for unnecessarily high tax bills to more than eat up whatever money you saved with a DIY divorce. That’s why it’s so critical for the DIY parties to study up on the tax code as well as Michigan divorce law.

For example, if you and your spouse have agreed on spousal support as a part of your divorce settlement then you need to know that this will usually be taxable income to the recipient and deductible the payer. This is a fact that many divorcing couples don’t realize, which can end up being a missed opportunity for the payer to recoup some of their financial losses. However, Sections 71 and 73 of the Internal Revenue Code set forth specific requirements for those payments to be  considered as alimony. For example, the payments must be made in cash, check or money order (no promissory notes, transfers or use of property, or transfers of services are considered to be acceptable.) Also, spousal support may not be treated as child support, and the couple must be no longer living in the same home. Michigan law also differentiates periodic alimony from alimony in gross. (Note also that most divorces do not include spousal support payments. Michigan law, in the Staple case, sets forth specific language that has to be used to bar future spousal support payments.)

6. Misunderstanding Long/Short Term Asset Values

Sometimes divorcing couples get so caught up in the minutiae of their divorce that they fail to look ahead and see the big picture. This is even more likely when the divorce is contentious and emotions are running high. When it comes to asset division however, this can be a real problem, because some things appear to have greater value now than they will in the long run, and vice versa – some items will decrease in value over time.

When divorcing spouses split assets, the goal in Michigan is to be as fair as possible. But it doesn’t always work that way. One example of this is when one person takes the house and the other one takes the the retirement fund. They might both seem to be of equal value at the present time, but in the future that will probably change. The house is unlikely to incur capital gains tax during a future sale if that person continues to live in it and not sell. But the person who ends up with the retirement account will eventually have to pay taxes on that money if the retirement account is one that defers taxes. Although true pension plans, sometimes called defined benefit plans, are rarer these days, they do still exist. Placing a value on the marital portion of a defined benefit plan is a task best left to a pension valuation expert. Another option will be to divide the pension using a specific kind of court order called a Qualified Domestic Relations Order.

Another example of this issue is when one spouse agrees to take the family home with the idea that they could sell the house after it has appreciated. But significant appreciation could result in substantial capital gains taxes, which is an unexpected loss for someone who hoped to keep the profits of the sale. Conversely, if the market struggles, a valuable house could end up worth a fraction of what they had hoped for, which means a loss in the assets they took away from the marriage to begin with.
All in all, structuring a settlement in a Michigan divorce case is very complex. It is not simply signing a paper and no longer being married to someone anymore. There is much more at stake. So if you are insistent that you would like to pursue a DIY divorce, then we advise you to ensure that you know as much as possible about every aspect of the process as you can. Because in a situation like this, ignorance is most certainly not bliss! Take the time to research all of the applicable laws before making any final decision.