Tax and Financial Planning Considerations Often Overlooked in Divorces in Indiana
There are numerous assets and debts involved in a divorce case that are easy to identify, such as real estate, bank and retirement accounts, credit cards, automobiles and household goods and furnishings; however, there are several other potential assets and liabilities that are often overlooked by clients and attorneys as they relate to benefits or liabilities that may result for income tax purposes. As such, it’s important to be aware of the following considerations to make sure you are receiving a fair deal in your divorce and that you won’t be blind-sided with tax or other liabilities down the road that could have possibly been avoided during the divorce process.
Capital Gains and Losses
If you have stocks or other investments, you have to consider the consequences of capital gains and capital losses. Capital gains and losses are realized for tax purposes upon the sale of such investments. When you sell a stock for example, to determine whether you have a capital gain or loss, you subtract the cost basis, (the amount you paid for the stock), from the actual sales price of the stock. If the result is a positive number, it is considered a capital gain.
There are 2 types of capital gains, long-term and short-term. The gain will be considered long-term if you owned the investment for 1 year or longer prior to selling it, whereas a short-term gain is where you owned the investment for less than a year. On the Federal level, long-term capital gains are taxed at a rate of 0% to 20% depending upon your income level and short-term capital gains are taxed as is ordinary income, at a rate of 10% to 39.6%. As a result, being awarded an asset where capital gains will result may make such an asset more or less attractive in a divorce. For example, $10,000 from a bank account can be spent at the owner’s will and there are no tax consequences associated with it. On the other hand, $10,000 in stocks cannot be spent by the owner until the stocks are sold and, as the capital gains will be taxed, it may result in the asset being worth less than $10,000. So if you are in need of cash right away after the finalization of the divorce, you may rather argue to be awarded the bank account as compared to the stocks. On the other hand, if you are not in need of cash right away and can hold on to the stocks for several years, you may want to argue for the stocks because that asset may increase in value over time to the point where the capital gains, even after being taxed, may be worth more than $10,000.
A capital loss is when a negative number results after subtracting the cost basis from the sales price. For any taxable year, if your capital losses exceed your capital gains, up to $3,000 in losses can be deducted from your taxable income on your tax returns. If you have more than $3,000 in capital losses in a given year, the amount that exceeds the $3,000 maximum can be carried forward indefinitely to offset future tax liabilities. As such, a capital loss carryover is considered a marital asset that should be addressed during a divorce. Failure to consider this as an asset can result in what the parties believed to be a 50/50 division of the marital assets and debts to actually being tilted in favor of the party who claims the carry over losses in future, post-divorce years.
Similarly, charitable gifts can also result in beneficial tax carryovers. Depending upon the type of charitable gift, the gift may be limited by the IRS to various percentages of your adjusted gross income, which can be 20%, 30%, or even 50%. If you have made a charitable gift that exceeds the applicable IRS limit, the excess can be carried over to offset future tax liabilities for a period of up to 5 years, (with limited exceptions). This means that charitable carryovers should be considered a marital asset as are capital loss carryovers.
It is also important to be aware of the tax consequences of different types of retirement accounts. For example, let’s consider the differences between a traditional IRA and a Roth IRA. Contributions a person makes to a traditional IRA are pre-tax dollars, whereas contributions to a Roth IRA are post- or after-tax dollars. As such, they have different tax consequences. For retirement accounts, such as the traditional IRA, that are funded by pre-tax dollars, all gains in the account are taxable when the person begins receiving distributions because the money funding the account was not previously taxed. For retirement accounts, such as the Roth IRA, that are funded by after-tax dollars, none of the gains in the account will be taxable since the account was funded by money already taxed. The take away from this is that retirement accounts with after-tax contributions are tax advantaged assets as compared to those with pre-tax contributions. For example, a party who receives a $10,000 Roth IRA, as compared to a $10,000 traditional IRA, may result in much less of the asset being taxed when the person begins receiving the distributions and so the Roth IRA may likely be worth more than the traditional IRA after tax time comes.
Indiana 529 Plans
529 plans are typically used for contributing to and saving for a child’s or other person’s educational expenses, such as for college. Once you contribute to such an account, the money can accrue value over time as it can be invested similar to a retirement or investment account and so it has advantages over just putting the money away in a savings account for use later. Further, there are associated tax benefits. Indiana allows up to a $1,000 annual tax credit for Indiana taxpayers who save for college education through an approved 529 Plan. The credit gives you a 20% credit for every dollar contributed. So for example, $5,000 in annual contributions will provide you with the maximum $1,000 tax credit as 20% of $5,000 is $1,000. What this means is that if one or more parties to a divorce have been contributing to a 529 Plan for the child(ren) of the marriage, the parties should take into account the allocation of any accrued tax credit for a 529 Plan when considering the division of assets and debts as the tax credit can be considered a marital asset.
If you are thinking about a divorce, child custody, or support case, the attorneys at Banks & Brower, LLC can help you. Give us a call at (317) 870-0019, or email us at firstname.lastname@example.org. We are available to take your call 24/7/365.