Avoiding or Identifying Financial Games in Divorce

Thoughtware Alert Published: Mar 29, 2022

Unfortunately, financial games in divorce happen more than we’d like to see. Financial games may cause the assets on the marital balance sheet to be overvalued or undervalued, resulting in a more favorable outcome to one spouse. Here are some common games to watch out for. 

Ignoring the Tax Impact on the Marital Balance Sheet

Many marital balance sheets simply list the assets in positive amounts and the debts in negative amounts with a total or net value at the bottom, which is split 50/50. Without applying the taxes that will be applied in the future to the assets, one spouse will be left with less than 50 percent of the marital assets. 

Consider retirement accounts such as a traditional individual retirement account (IRA). There will be taxes on the distributions from a traditional IRA upon retirement. This is a “pretax” asset. You can work with your tax advisor to estimate the proper amount of tax that should be applied to this asset to calculate an after-tax value. It is the after-tax value that should be included on the marital balance sheet. 

As an example, the couple has $1 million in assets and $200,000 of debts for a net of $800,000, or $400,000 each. However, within the $1 million of assets is an IRA of $300,000. The tax advisor indicates that the after-tax value of the IRA is $225,000. Therefore, the actual net amount on the marital balance sheet is $725,000, or $362,500 each. 

Had the after-tax value not been applied and one spouse received 100 percent of the IRA during the division of marital assets, that spouse would have received assets worth $325,000 while the other spouse received $400,000. 

Not all marital assets have a future tax liability. For example, a Roth IRA is funded with after-tax money; therefore, there is no income tax on the distributions from this retirement plan. Consult with your tax advisor to identify which of your marital assets should have future taxes considered. 

Double Dipping on a Business Value & Earnings for Maintenance

Ownership in a business or value of retirement accounts is valued for the marital balance sheet as the value will typically be shared 50/50. To then include the earnings from this asset as income for one spouse for the purposes of calculating maintenance is a double dip

For example, Spouse 1 has a significant retirement account valued at $1 million for the purpose of the divorce. Spouse 2 receives the equivalent of half, or $500,000, in equity in the marital home and other assets, while the full retirement account remains with Spouse 1. Once Spouse 1 retires and the retirement account starts to pay benefits, this income stream should not be included in the calculation for maintenance of Spouse 2. Inclusion of this revenue stream would double dip, as Spouse 2 received 50 percent of the value of the asset during the divorce and cannot then receive value from this same asset in the future. 

This example works the same for dividing Spouse 1’s ownership in a business. If your divorce includes assets that can be valued now and can pay out in the future, be aware of this double dip concept in your plans for the division of assets and maintenance calculations. 

Other Financial Games

Unfortunately, business owners may play some financial games when facing a divorce to reduce the amount paid to their spouses based on the value of their business. These games can look like the following: 

  • Manipulation of business operations to decrease the value of the business, such as increasing expenses to lower profits, holding off on new projects, or decreasing sales efforts to lower revenue, thereby reducing profits. 
  • Over-withholding individual income tax on their paycheck and waiting until after the divorce is complete to request a refund. 
  • Overpaying corporate tax and waiting until after the divorce is complete to request a refund. 
  • Overpaying colleagues with the understanding that the amounts will be repaid after the divorce is complete. 
  • Receiving payments from customers in cash and not reporting the revenue within the business’s books and records. 

While we’ve seen all these types of games, they are not easy to identify. If you feel these types of manipulations are happening, alert your legal counsel and reach out to your financial advisor for assistance. Our forensic accountants are ready to dig into the financial records and assist with these concerns. 

For more information, reach out to your advisor or submit the Contact Us form below.
 

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