Divorce Mediation Equitable Distribution and Taxes

There’s not much as a New Jersey divorce mediator I can do to prevent the IRS taking it’s share of your earnings, but for couples using our mediation service, I can help you avoid some unpleasant surprises down the road with regard to your divorce and the potential tax liabilities on your equitable distribution, child support or spousal support / alimony.   In today’s I’d like to address equitable distribution.

For those of you unfamiliar with the concept, equitable distribution is simply the division of your marital assets and liabilities to determine what share each of you will receive as part of your divorce settlement.  When it comes to taxes and equitable distribution, there are two issues at hand we need to look out for in mediation.  First is that of unwittingly creating a tax issue with the transfer of an asset when one should not be created and the second is not taking into account the pre-tax and post-tax value of such an asset being transferred.

In the first instance the IRS’ rule is that the transfer of assets which take place as a result of a divorce decree will not result in a taxable event.  Notice I didn’t say are never subject to tax but rather when transferring the assets, the transfer will not result in a taxable event but when the recipient goes to exercise those assets they will pay any subsequent taxes due at that time.  For example, as part of a settlement, your soon to be ex agrees to give you $10,000 from their 401k as part of your equitable distribution and let’s assume you are both 45 years old.  Normally, if your ex would take a distribution from their 401k prior to age 59 1/2, they would get hit with taxes and a 10% early withdrawal penalty.  However by using what’s known as a QDRO, we can avoid the taxes and penalties on this transfer as long as it is the result of your divorce and outlined in your Memorandum of Understanding.

In the second example, when calculating your equitable distribution you’ll want to make sure to understand which assets are subject to tax and which ones are not.  For example, let’s say you’ve been married 25 years and have a stock portfolio that you first assembled when you got married which has tripled in value and you’ve never touched it.  Your ex decides to give you 100% of that asset in exchange for an equal amount of cash from your savings account.  On the surface, this looks like a fair trade and a dollar for dollar match but it’s not.  The cash is just that: cash while the stock portfolio has increased in value and you will pay some hefty taxes on the gains of those stocks once you go to sell them, reducing your total by a substantial percent.  In order for this to be fair and equitable, you’d need to be compensated an additional amount to make up for that tax burden or each take a share of the stock and the cash so you each have the same tax burden.

In our next post, we’ll take a look at the impact of taxes on child support and what you should be aware of when speaking with a New Jersey divorce mediator.  Please note that this article is not meant to be construed as legal or tax advice and that since everyone’s situation is unique, it’s always best to consult with your accountant mediation service, or NJ mediator regarding your specific situation especially when it comes to taxes as the IRS is not an organization you want to get on the bad side of!

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Equitable Mediation Services is a New Jersey divorce mediation practice serving Somerset, Mercer, Middlesex, Essex, Morris, Union and Hunterdon counties including the towns of Edison, Parsippany, East Brunswick, West Orange, Bridgewater, South Brunswick, Hillsborough, Livingston, Randolph, Maplewood, West Windsor, Summit, Plainsboro, Millburn, Morristown, Montgomery, Madison, Readington, Branchburg, Warren, Princeton, Metuchen, Lawrenceville, Pennington, Short Hills, Bernards, Bedminster and surrounding areas.