The recent tragic death of Anthony Bourdain sheds light on how very common “uncommon” marital situations have become. At the time of his passing, it was noted that Bourdain had been separated for a long time, but never legally divorced. In keeping with the “new normal” roles of today’s modern family structures, many couples choose to co-parent but don’t rush to formally divorce. With this decision comes tax and financial implications – both positive and negative. Estate tax effects, retirement plans, and many other spousal rights all need to be carefully considered, according to BNY Mellon Wealth Management’s national wealth strategist Jere Doyle.
For starters, the joint return filed by most couples can present some issues, he indicated.
“For legal and tax purposes, those who are separated but not divorced are still married for tax and legal purposes,” he said. “They can file a joint return if they want, but they should realize that the liability is ‘joint and several.’ If there’s a deficiency, the IRS can come after either the husband or wife, or both. They may realize too late that the other spouse did not report all of his or her income.”
“Another thing that might be overlooked is that even though they’re separated, they still have inheritance rights,” he said. “A spouse might mention that they changed their will, or are going to ‘write my spouse out of the will.’ That’s fine, but regardless of what state you’re in, there’s a statutory ‘forced share.’ So if I and my wife separate and I change my will to leave everything to my two kids, she can go to court and waive the will and get what in most states would be a one-third share. And in community property states, each owns half of the marital assets.”
“The point is that the spouse still has rights and is entitled to a certain amount of the estate,” he added.
“Some people try to get around this by moving their assets to a ‘living trust,’ but many states have augmented their definition of ‘estate’ for purposes of the statutory forced share, to include assets transferred during lifetime to a living trust. You have to look to state law to see if the definition of estate includes not only probate assets but the augmented estate including assets transferred during lifetime.”
For those who don’t have a will, Doyle noted that state laws of intestacy give a marital share to the surviving spouse. “There’s the statutory forced share if there is a will, and an intestacy share if there is no will,” he said.
“Another issue people who are married but separated should consider is the possibility that they might inherit from their parents,” Doyle observed. “If a spouse inherits from their parent, it’s an asset that will be counted in a division of property between husband and wife. If I would like to have the asset but not have it count, I can ask my parents to leave the property I would inherit in a fully discretionary trust with an independent trustee. I don’t want a related party – such as a brother or sister – to be the trustee. That way, when mom and dad die, I can argue that I don’t have the property, just an expectancy.”
“I would recommend that the trust have more than one beneficiary,” Doyle said. “Then it looks like the trustee has the discretion to distribute to someone other than one beneficiary. This will give more protection for the assets you might receive in an outright distribution from a deceased parent. ”
A separated spouse generally has no rights over the retirement plan of their husband or wife, and often has no clue as to what the other spouse is doing with the assets. But when people file an actual complaint for a divorce, a restraining order automatically issues that prohibits the separated spouse from moving money around, according to Doyle: “Short of a formal complaint for divorce, there’s nothing to prevent a spouse from changing title to assets.”
One of the biggest reasons people separate but don’t divorce is the need for health insurance, Doyle noted.
“A lot stay married because they’re covered by health insurance that they otherwise couldn’t afford. This might be especially the case if one of them has a pre-existing condition and can’t get adequate insurance,” he remarked. “And they may want to stay separated but married until they’re 65 and eligible for Medicare.”
Tax benefits abound for married couples, which is another reason to stay married, Doyle suggested. “The Tax Code has 1,138 provisions that give benefits to married couples which would include couples separated but not legally divorced,” he said.
One such provision is Code Section 1041, which provides that no gain or loss is recognized on a transfer of property spouse, or to a former spouse if the transfer is incident to a divorce. “Spouses can transfer appreciated property between themselves tax-free,” he said. “They can flip property back and forth without tax liability.”
But one provision in the Tax Cuts and Jobs Act makes it worthwhile for those who may get divorced to do so by the end of 2018, Doyle indicated. That’s a result of the elimination of the deduction for alimony. Now alimony will no longer be deductible by the payor, and the income will not be taxed to the recipient, meaning, in most cases, that there will be a smaller pot of funds available to split between the divorcing spouses.
“People who are separated but not divorced should consider whether they want to take advantage of the alimony deduction for the larger wage earner,” he said. “It has to be before the end of 2018.”