Divorce is always painful, but for the wealthy, calling it quits can be especially complex from a financial standpoint.
High-net-worth couples must assign valuations to substantial assets—which might include businesses, investments and multiple properties—and divide those assets fairly while taking tax considerations into account. While professionals can help an individual navigate the financial implications of divorce, understanding the various items to consider is critical to creating a fair outcome.
Why Taxes Are the X Factor When Dividing Assets
It’s not enough for a divorcing couple to split their assets down the middle based on their face value. Taxes can significantly affect the net value of transferred assets. In divorces, the transfer of assets between spouses is typically treated as a tax-free event, meaning there is no immediate recognition of capital gains or losses. Critically, however, the receiving spouse does not get a step-up in tax basis for the assets received.
Tax basis is an asset’s cost basis for tax purposes. The step-up in tax basis usually occurs when assets are transferred after the previous owner’s death. In that case, the assets receive a new tax basis equal to their current fair market value. This step-up in basis can reduce or eliminate capital gains taxes when the assets are later sold by the inheritor.
In a divorce, the receiving spouse retains the original tax basis of the assets, which means any unrealized capital gains up to the date of the divorce may be subject to capital gains taxes upon future sale. Bottom line: Assets including pre-tax retirement accounts should be divided based on projected after-tax value not on face value.
Getting Business Valuation Right
Ownership of a business is often a couple’s largest asset, so accurately valuing the business is critical to ensuring a fair division of marital assets. If one spouse wants to retain the business, a proper valuation helps to determine a fair buyout price. If the couple decides to sell the business, an accurate valuation will help set a realistic asking price and ensure a fair outcome. Bear in mind that the valuation of the business can impact tax liabilities, especially if capital gains or losses are involved.
In a divorce, the valuation of a business is typically determined by an independent appraiser. A divorcing couple or their attorneys may hire their own appraisers to provide separate valuations, or they may mutually agree on a single appraiser to conduct the valuation. If they can’t agree, the court decides based on the information provided to it. For more on business valuation, see our related article on the topic.
Don’t Overlook Life Insurance
Life insurance can be a crucial component of a divorce settlement, but it’s easy to overlook amid the emotionally charged discussions of other assets. Married high-net-worth couples purchase life insurance for a variety of reasons, including to help ensure that a surviving spouse can pay off a mortgage, that outstanding business debts can be paid, or that children’s education expenses can be covered.
It can make sense to keep life insurance policies in force after a divorce if the original reasons for having them remain relevant or to insure the loss of support for a dependent spouse in the event of the supporting spouse’s death. The terms and beneficiaries of the policies may need to be updated to reflect the changed circumstances and ensure that the intended benefits are still realized.
Updating the Estate Plan
It’s important for divorced individuals to update their estate plans to reflect their new circumstances. Those typically include a newly established portfolio of assets and can include a changed tax situation. Currently, estate taxes are levied if an individual’s total assets transferred exceed $12.92 million1 in value.
Divorce can change the dynamics within a family, including relationships with children from previous marriages. Wills and trusts may need to be revised to reflect changed wishes regarding asset distribution, guardianship of minor children and appointment of new trustees or executors.
Beneficiary designations will likely need to be updated on retirement accounts, life insurance policies or other accounts. Divorce may also alter an individual’s philanthropic goals, leading them to establish a new charitable foundation, for instance. Updating your estate plan can help reflect your revised charitable intentions.
Along with a divorce lawyer, those going through divorce should consider working with a wealth advisor. Your team can help you understand the financial implications of your divorce, assess whether the division of assets is fair and highlight the tax consequences of different settlement options.
Creating Your Own Wealth Plan
Post-divorce, it’s essential to create a new comprehensive wealth management plan. After all, individuals’ financial profiles, priorities and goals tend to change significantly after the dissolution of a marriage.
Fairly dividing significant and complex assets can be a daunting challenge, especially during a period of emotional upheaval. But facing up to the financial issues associated with divorce can lead to the best possible outcome, creating a strong financial foundation for the coming chapters of your life.
1 “Estate Tax”
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