When a couple files for divorce, they aren’t just ending a marriage under the eyes of the law. The pair is dividing a life in which they earned money, purchased homes, made investments, built up retirement and much more. Property division is a major part of the divorce process.
Under Illinois divorce law, property is divided with the concept that each spouse is entitled to a fair share of the property that was accumulated during the marriage and responsible for the liabilities incurred. This theory is called equitable distribution, and although the “value” each spouse walks away with may look like a 50/50 split in many cases, it isn’t a requirement as it is in community property states.
Fair isn’t only a term that is used in describing the final numbers. Cash has a pre-determined, obvious value, but other assets don’t have such a clear definition. These assets must be given a fair value, a determination that can be a bit of a science. Tax consequences are one factor that must be considered in the division and valuation of assets.
For instance, a spouse may propose that the other takes the 401(k) retirement account with a balance of $400,000. Is this the same thing as taking $400,000 in cash? The answer is not really. These retirement accounts are funded with pre-tax money, which means that it will be taxed as income on withdrawal, effectively lowering the value.
Another consideration is the basis for items that have appreciated in value. Consider that taking these items comes with a built-in tax liability that will need to be paid upon realization of the gain.
The federal tax code does provide a way to transfer assets tax-free, like a piece of real estate with only one spouse’s name on the deed. Section 1041 sets terms for the general rule that property can be transferred tax-free between spouses in a divorce or within one year as long as it is made incident to divorce.
Of course, there are exceptions to every rule. Considerations such as these are why an individual in Illinois should seek the advice of an experienced divorce attorney.
Source: The Wall Street Journal, “What’s even worse than divorce? The taxes,” Bill Bischoff, Dec. 7, 2013