Question: During the divorce process, I have found out that our problem is not having enough cash-flow. Although I earn a good living, the bucks are not there to support the lifestyle we once enjoyed as a family. Although our net worth has increased, the income from the stocks we have purchased over the years is minimal (3 percent), and the capital gains taxes would kill us if we sold these assets. It seems that there should be ways in which to take advantage of what we have accumulated without getting pounded by the system and the government. Any "creative" ideas?
Answer: Last week, we discussed ways in which qualified retirement monies could be used to create cash-flow prior to recipients reaching age 59 and one-half -- without paying the 10 percent penalty. This week, how low basis assets can be used to create cash-flow -- without incurring capital gains taxes.
At divorce, assets change hands without an increase in cost basis. This means that the spouse who receives a low basis asset and sells it to create additional cash flow will pay a capital gains tax on the difference between the original cost of the asset and the sales price. So, for example, if $100,000 worth of stock was purchased for $20,000, when sold for $100,000, the selling spouse will pay the federal capital gains rate of 28 percent on the $80,000 gain ($22,400) plus the state capital gains tax rate. If we assume the state rate is 3 percent ($2,400), this means that only $75,200 would be available to create income for the selling spouse.
Charitable remainder trusts are trusts having intervening income interests for one or more non-charitable beneficiaries. The intervening interests may be paid for a term of years (not more than 20) or for the life or lives of the non-charitable recipient(s). When the intervening income interest(s) terminate, the amount that is then remaining in the trust will be paid to the charitable beneficiary. By using a charitable remainder trust, capital gains taxes will be avoided - thus making all of the sales proceeds available to generate income. In this way, the contributing spouse will receive more income and will be able to take advantage of tax savings because of charitable deductions.
There are two types of charitable remainder trusts: the charitable remainder annuity trust and the charitable remainder unitrust. The charitable remainder annuity trust pays the non-charitable income beneficiary(ies) a specified sum each year which is not less than 5% of the initial net fair market value of all property placed in the trust. The charitable remainder unitrust, on the other hand, pays the non-charitable income beneficiary(ies) a fixed percentage, not less than 5%, of the net fair market value of its assets, as valued annually.
Going back to our example: The spouse who receives the $100,000 in stocks in the divorce settlement currently receives $3,000 per year in dividends. If she sells the stock so she can reinvest for higher yield, she will pay capital gains taxes of $24,800, leaving her $75,200 for investment. Assuming she can get an 8% return on that investment each year, she will receive $6,016 per year.
If, on the other hand, she contributes $100,000 of stock into a Charitable Remainder Unitrust that will pay her 8% per year for her life, her annual income from the trust will be $8,000 and, based on her age, she will receive an income tax deduction which can be carried forward for five years. This deduction will offset some or all of her income taxes. If she prefers, she can make provisions in the trust so that her children will receive the chosen annual amount for their lives after her death. If she chooses this option, the amount of her charitable deduction will be reduced.
If concerned about wealth replacement for her estate, she could purchase a $100,000 policy of insurance on her life with her children owning the policy so that, at her death, her children would receive $100,000 tax free.
Although not for everyone, the charitable remainder trust is a tool that is being used more and more to create more cash-flow at divorce. When used, the trust should be considered as part of an overall financial management, divorce, and estate plan. Because of the technicalities involved, you should only deal with attorneys who are skilled in these areas of the law.
SoloFact: When you separate, be sure to sign durable powers of attorney so that, if you become incapacitated, someone you trust and have designated will be there to make your necessary financial and health care decisions. Without a power of attorney in place, incapacity could lead to lengthy, expensive, and otherwise unnecessary proceedings.
Jan Collins Stucker is an award-winning writer and editor. Jan Warner is a matrimonial, elder, and tax attorney. Both are based in Columbia, South Carolina. Flying Solo is seen in newspapers throughout the United States and on the Internet at http://www.flyingsolo.com.
