Tax Consequences of Divorce

Diving Property: When dividing property pursuant to a divorce or separation, one often overlooked fact is that not all assets are treated equally in the eyes of the IRS. When you are diving property you and your spouse must consider the liens attached to the property and the tax consequences of owning that property. It is essential that you and your attorney consider the tax implications of property division during your divorce or property settlement agreement.

Some transfers create taxable events. Some assets are worth more than others because of the tax implications. For example, the equity on the sale of your marital home is most likely tax-exempt income (subject to IRS requirements). The income in the pension or retirement account is most likely subject to tax upon distribution. Therefore, trading equity in the home, for money in the retirement account is not a 1-1 exchange. You must consider that the retirement income is subject to your effectivel tax rate.

As another example, if a husband gives property to his wife in exchange for not paying any alimony, this could create a taxable event. The Supreme Court ruled that because the Wife had no vested interest in the property, the release of her right to alimony had value, and the husband had realized a gain on the transfer- viola! We have a taxable event. The court treated the transfer as a satisfaction of an obligation and not division of property.

Since that time the IRS has created sec 1401(a). This section provides that no gain or loss is recognized in a transfer pursuant to a divorce. The basis moves with the property, so the receiving spouse will be subject to the tax implications of the property. Again, this means that the stocks currently valued at $100,000, may not be worth $100,000 upon distribution, a portion is most likely subject to capital gains tax.

Alimony: According to the IRS, alimony (spousal maintenance) is deductible by the payor and included as gross income to the payee. This is non-negotiable. If payments to a spouse under a divorce or separation agreement are not child support, they are likely alimony and the tax rules apply. This agreement does not need to be court approved. Even an informal agreement between the parties, triggers the IRS tax rules. However, if the parties are living together, it cannot be alimony. Also, if the payments are unilateral, they may be treated as a “gift”. Another requirement of “alimony” is that the obligation to may must cease at death.

Child support: Child Support is not taxable income of the recipient and it is not deductible by the payor. If a payor is in arrears, it is likely that any tax refund will be seized and instead provided to the parent who is owed child support.

Tax Exemption: The child tax exemption can be ordered to one spouse pursuant to an agreement or decree. If there is no agreement or written order, the parent who has the child for the greater portion of the year is entitled to claim the child.

Medical Expenses: Medical expenses are available as an itemized deduction by the parent making the payments.

Child Care: Qualified child care expenses can be claimed on a return, subject to IRS rules and limits. It is important to consider who will be deducting these expenses when determining who will pay for the child care.

Earned Income Credit: One additional tax claiming strategy is the earned income credit. This is only available to low income tax payers who provide a home for a dependent minor child.

As you can see, the tax implications of divorce or separation can be complex and substantial. If you have questions relating to your divorce or separation, give the office a call for a free consultation.