As you know, a 50/50 division of assets may NOT be fair, because the after-tax picture can be very different.
Family Law Software includes the very valuable feature of enabling you to help the parties reach an agreement on dividing their assets on an after-tax basis.
Click Negotiate > Property After-Tax
We know that this approach will not work in most litigation contexts, because the court will not permit this kind of speculation.
But it can be incredibly useful in a mediated, collaborative, or negotiated settlement context — especially when there are significant retirement assets or appreciated assets.
Below are details on using this valuable feature.
After-Tax Property Division – The Basics
When you click Negotiate > Property After-Tax, you will see the screen shown below. (The images in this e-mail are from the Cloud Edition of Family Law Software.)
You will see that the screen has several sections.
- Key tax rates used. These are the tax rates that are used in the after-tax calculation.
- Percent paid in tax. This section shows the calculation of percent paid in tax for each asset.
- Marital property division on an after-tax basis. This is the bottom line result.
- Line item detail (not shown in the image above). This shows each asset and allows you to change the percent of assets allocated to each party.
The next sections of this newsletter discuss these four sections further.
Key Rates Used
We calculate the tax to be paid assuming that capital assets will be sold today and that retirement assets will be distributed in retirement.
Our first step in figuring the after-tax value of assets is to calculate the two key tax rates that will apply:
- The ordinary income rate that will apply in retirement. This is for retirement assets such as 401(k) plans and defined-benefit pensions.
- The current capital gains rate. This is for capital assets such as securities and real estate.
You can click the links labeled “explain” and see how we get each number.
Each of these numbers is a guess — especially the tax rate in retirement.
There will be a message (shown in the image above) if the projection in the case does not go until retirement. You may increase the number of years projected on Files & Settings > Settings > Assumptions > Number of years for cash and net worth projections.
Or, just override our guess of the tax rate that will apply to the retirement income.
You may override each number if you have a better guess than we do — which may well be the case.
Percent Paid in Tax
The next step is to determine the percent of each asset’s value that will be paid in tax when the asset is sold or distributed.
In your software, click the links illustrated in this image to view the calculation.
The software is making various assumptions to do these calculations. These assumptions are spelled out along with the explanation of the calculation.
You should check our assumptions, and, if they are not correct, you should override the percent paid in tax that we calculate.
After-Tax Property Division Worksheet
The next section has a worksheet like the Property Division worksheet, but showing after-tax values.
Note the columns (a) through (g) in the image here.
Here is what each column means:
(a) Pre-tax marital equity. This is the same as on the Property Division Worksheet.
(b) % kept. This is the % allocated to that party, also the same as on the Property Division Worksheet. Note that there is no column to enter “Dollars to Able,” because the after-tax dollar is a calculated amount, not a user entry.
(c) % paid in tax. This is carried from the calculations above. This is calculated as: (tax payable / marital equity). For example, if an asset worth $10,000 would result in tax of $500 upon sale, then the % paid in tax is $500 / $10,000, or 5%.
(d) After-tax equity. This is column (a) * column (b) * (1 – column (c)). For example, suppose pre-tax equity in column (a) is $10,000, Able’s % in column (b) is 50%, and the % paid in tax in column (c) is 5%. The calculation is as follows:
- Before tax, Able’s share is 50% of $10,000, or $5,000.
- Taxes will take 5% of that, leaving him 95% after tax.
- After tax, he will have 95% of $5,000 = $4,750.
Columns (e), (f), and (g) are the same as (b), (c), and (d), but for the other party.
And that’s it! We have calculated each party’s share of the after-tax value of each asset.
No Equalization Payment
You will note that there is no equalization amount shown for the after-tax property division.
This is because an equalization amount would have to be expressed in after-tax dollars.
But there is no straightforward way to use that information.
You have to tweak your ownership percent until you hit the desired after-tax division.
A Very Valuable Tool
As you can see, the after-tax property division goes to some lengths to try to give you an accurate assessment of the value of each asset on an after-tax basis.
Each asset is individually calculated, based on the tax attributes of that asset and the assumptions we make. (You should check each calculation, to make sure our assumptions are reasonable under the circumstances.)
The results roll up to a very complete best-guess of the after-tax consequences of the property division.
This is a very valuable feature. It can make your property divisions significantly more fair by the measure that really counts — value after tax.