Just the Three of Us: You, Me and Uncle Sam

In law school, my family law professor was fond of saying there are three individuals in a marriage, the husband, the wife and the government. In addition to a host of other consequences of marriage, the Internal Revenue Service plays a critical role, both while you are married, and while you are separated or divorced. While there are many reasons a separation agreement should be prepared by an attorney, I will limit this article to one of the most important reasons, the IRS. While I am an attorney, and not a financial adviser, there are several red flag issues to be addressed when you and your attorney begin to make decisions about a property settlement.

Why Can’t I just write my own Separation Agreement?

There are tax consequences for the status under which you file your taxes, whether you file jointly as husband and wife, married but separated, or some other status. Additionally, a share of certain daycare expenses might be deductible to a parent, and only one of you may claim your child as a dependent. If you and your spouse have not filed taxes as required, and not made arrangements to get an extension, you are playing with fire, not to mention steep penalties and fines. The IRS may deduct tax payments from your salary in certain cases, or create a lien against your residence or other real property. You will not only have serious problems with the IRS, you will also have problems in family court if there is a future motion to change support. In most cases, tax returns and the attachments (W-2 statements, for example) must be provided to the court when necessary to determine income. A new layer of concern applies if one or both spouses are self-employed but there are no tax returns filed because there is no clear answer, or even a starting point, as to what that person earns for purposes of calculating child support and/or alimony.

Retirement

There are tax consequences associated with retirement division, and failure to correctly roll over or divide a retirement account. Depending on your age, you might be saddled with tax penalties for early withdrawal or failure to take required minimum distributions from an account. If a retirement account or benefit is divided by a court order, there are certain additional requirements to satisfy the IRS that the part of the account that was rolled over remains tax deferred instead of being taxed as income and additionally penalized.

The Buy-out of the Marital Property

If one of the spouses keeps more assets than the other, there is often a “buy out” called a distributive award. In order to avoid unnecessary tax on this type of award, there are certain time periods by which the award must be paid. Back in the days of the real estate boom, clients often took out a home equity loan to make the buy-out and deducted the interest. Now, in the wake of the real estate bust, it is less common for people to qualify for this type of loan.

The House

The family home presents another opportunity for the IRS to strike. If you have a mortgage, there are mortgage interest deductions that should be addressed, and if there is alimony, there is another set of rules with which you must comply. With the down economy, more and more home owners are negotiating their mortgage terms with their lender to avoid foreclosure. If you manage to get some share of the mortgage to be reduced, there may be a requirement to claim the dollar amount of any loan forgiveness as a benefit to you. People who “save” money by skipping the advice and services of an attorney by preparing a homemade agreement may end up spending a great deal more to the IRS than what they save.