Johnny Depp a.k.a. Capt. Jack Sparrow is in the news again, this time for his failure to pay Amber Heard a $7 million divorce settlement. Heard had promised that any settlement that she received from Depp would be donated to charity. She has chosen two charities, the American Civil Liberties Union and the Children’s Hospital of Los Angeles to be the beneficiaries of her largess. Depp hasn’t made the payout yet because he wants to pay directly to the charities rather than to Heard. At issue is the substantial tax benefits that Depp would reap by making the payments directly to charities rather than Heard.
Tax consequences of divorce disbursements is an important consideration when negotiating a settlement. Often times the client will simply lump all assets together and come up with a value of the marital estate not taking into consideration possible tax issues for each individual asset. For instance, the average couple may have a house with $250,000 of equity, a 401(k) with $500,000, and various bank accounts equal to $250,000. The easy math would suggest that one spouse take the 401(k) and the other take the accounts and the house, right? Not so fast. The spouse who would walk away with the house and the bank accounts could liquidate everything and have $500,000 to spend now. The spouse with the 401(k), however, has significantly less available liquidity. Assume, for example, that the spouse that takes the 401(k) has an overall 30% tax bracket for state and federal taxes. To liquidate the 401(k), that spouse would have to pay not only 30% in taxes, but absent extraordinary circumstances, a 10% penalty to liquidate the retirement early. All too quickly that $500,000 becomes $315,000.
This simplistic example demonstrates the necessity of understanding tax consequences to all of the assets in a divorce. This includes stocks and bonds that may have been purchased at a low price that have gone up substantially in value, retirement accounts, real estate investments which in and of themselves may have tax consequences such as available deductions, and carry forward losses on prior tax returns. In the rush to settle the case, litigants sometimes forget the importance of the careful review of their prior tax returns and asset portfolio. A quick call to your accountant may assist your attorney in protecting your future significantly.