Divorcing clients often believe their estate is simple and will lead to an easy division of the marital property. Families often spend time and resources on estate plans to simplify matters at death, and they conclude divorce will be similarly impacted. This may not be the case. While they may be right about much of their estate, divorce brings some different considerations that may increase complexity in the division of assets and debts that would not otherwise be part of the conversation.
Taxation of Irrevocable Grantor Trusts
Clients who have established irrevocable grantor trusts such as SLATs, Spousal Lifetime Access Trusts, as an estate planning tool to move assets out of the estate while still providing access to them, know that the taxation of income related to the SLAT is reported as income on the marital tax return. SLATs are generally created by one spouse, the grantor, for the benefit of the other spouse, the beneficiary. This tax treatment is not problematic during the marriage as the income of the SLAT can be withdrawn to pay taxes and for other needs. However, practically speaking, the income is actually attributed to the grantor spouse who must pay the tax on the income.
The Tax Cuts and Jobs Act of 2017 included provisions that this tax treatment would survive divorce, meaning that post-divorce, the grantor spouse would be liable for the tax on income of a trust for which the other spouse is the beneficiary, with no inherent right of reimbursement and often no control over the income generation decisions. Addressing this in divorce is complex and often requires the involvement of financial and estate experts to attend to all of the repercussions of this unintended outcome.
Tax Loss Carryforwards
Different assets can produce a variety of tax loss carryforwards such as capital loss carryforwards and net operating loss carryforwards. Tax loss carryforwards can have real cash value as they represent a potential offset of future tax liability. In general, divorcing couples cannot arbitrarily decide which of them will have the benefit of the loss carryforwards. Rather, the loss carryforwards are considered part of the tax characteristics of the asset that generated them and typically accrue to the spouse to whom that asset is awarded in the divorce. The ability to receive and use these loss carryforwards is an important consideration in decision-making about property division.
Clients often forget that in addition to tax loss carryforwards at the federal tax level, there are often tax loss carryforwards at the state and local level. State and local tax loss carryforwards can take longer to utilize as they are applied to what is considered income earned for that state or locality. When considering the value of an asset, it is prudent to also consider the benefits of any tax loss carryforwards that might accrue to whomever is awarded the asset. Additionally, there may be a benefit to executing a sequence of steps to enable the spouses to fully utilize and benefit from tax loss carryforwards, depending on the intended settlement outcome. The right financial expert can help identify the tax loss carryforwards and assist with considering their impact and utilization in the divorce context.
Illiquidity Concerns
Some high-net-worth estates include considerable illiquid assets. While the assets themselves may be awarded to one spouse or the other to affect an equitable division of the marital estate, it may not solve cash flow concerns for both spouses post-divorce. This may be of particular concern if one of the spouses needs to qualify for a mortgage post-divorce and does not have sufficient income history as sometimes happens when one spouse has not worked outside the home for some period of time. Creative thinking from the financial experts on the divorce team can help consider ideas to structure the division of property in a way that may qualify as support for the purpose of mortgage qualification and address cash flow needs for both spouses.
Premarital Assets
Spouses often enter marriage with considerable assets and may not have a prenuptial agreement that would help protect those assets in the event of divorce. They may believe what they brought into the marriage is undisputably theirs and there is no need for a prenuptial agreement. They may or may not be right. Many jurisdictions recognize premarital assets, and potentially, the growth on those assets as the separate property of the owner-spouse. However, individuals sometimes change title of the assets to add their spouse, they may contribute marital funds to their premarital accounts, their spouse may be involved in managing and growing the assets, and there may be other considerations that muddy the water and make discerning the premarital value of assets challenging. Those in long-term marriages also face the sometimes difficult hurdle of obtaining financial records that predate the marriage. Financial experts are invaluable to the divorce team in assisting with identification and valuation of premarital assets.
Prenuptial and Postnuptial Agreements
Frequently, those who have prenuptial or postnuptial agreements that govern the division of assets and debts in divorce believe their divorce will be easy and a mere formality. It depends. Such agreements written in the past cannot always address all current day circumstances, and the spouses may or may not have updated or amended the agreement over time to take new events or even evolving tax considerations into account. This can lead to an unintended consequence. And, if the spouses have not lived by the terms of the agreement, it may invalidate or muddy portions of the intended outcome. Financial experts can assist the divorce team in understanding the financial and tax implications of the agreements and their real-life execution in current-day circumstances, as well as advise on practical solutions to address concerns.
These are just a few of the hidden complexities inherent in high wealth divorces. While the marital estate may appear easy to divide on the surface, divorce brings special considerations best addressed with the assistance of experts. Shareholder Cheryl Panther and LBMC’s Family Law Support Services are ready to join your team and provide high-quality advice and creative thinking to the complexities of your situation.
LBMC, PC, is not a law firm and no portion of this website and associated blog content should be construed as legal advice. To the extent a reader has any questions regarding the applicability of any specific issue discussed herein to their individual situation, they are encouraged to consult with the professional adviser of their choosing.
Information included in this website and associated blog is for educational purposes only and is not intended as an offer or solicitation for the sale or purchase of specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Please consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance may not be indicative of future results.
