What Tax Considerations Arise in a Divorce?

Let me start this blog by stating that this blog entry is not to be considered tax advice. Everyone is advised to seek the advice of an appropriate tax professional, such as a CPA, regarding tax questions. This blog, however, is intended to identify some issues and language to be considered when trying to address the tax issues that commonly present in divorces. These matters should be considered when planning, drafting and negotiating a divorce settlement with your divorce lawyer or mediator.

Each case and agreement is different, so the following is intended to be illustrative only. Tax filing status is a big consideration when divorcing. Some common language in a settlement agreement might provide that the husband and wife can file taxes jointly or separately if they so choose for any tax year that they are still married at some juncture during the year. In that event any tax refunds received are often designated by the agreement as the Separate Property of the recipient spouse. The settlement can also state that if both sides agree to filing jointly, they may do so only so long as they are able under the tax laws. In what proportion any refunds or taxes owed should be discussed such as whether everything (refunds or amounts due) is going to be shared equally or in proportion to the respective contributions towards taxes or responsibility for any shortfall.

There are various divorce tax considerations involving children. Frequently, as part of the divorce settlement agreement, the parties discuss claiming the children as dependents on the tax return. An example of possible language could be as follows. If any of the children may be claimed, so long as the claiming party is current with their child support obligations, if any, it is agreed that if permissible under applicable tax laws, and there is a financial benefit to the party seeking the claim, the couple shall alternate or share claiming the children. The agreement should spell out how the parties should share that claim such as alternating each year if there is one child or for one parent to claim two children (if for example there are three) during one year and one child in the subsequent year. It is important to include that each will sign promptly Internal Revenue Service Form No. 8332 if necessary, or its equivalent, in order to carry out the dependent claim agreement.

Child support is not a tax deduction for the payor and correspondingly, child support is not income to the recipient. Maintenance, formerly known as alimony, on the other hand, is a tax deduction from income to the payor and likewise it is income to the recipient. The interplay of child support and maintenance therefore can be strategically negotiated since there are benefits and detriments associated with how the money is categorized. These can be negotiating points.

The actual distribution of marital property between spouses is usually not in and of itself a taxable event, with certain exceptions, although certain property might have taxes that eventually will be associated with them. For example, a house can eventually have capital gains tax due. When distributing property, great care should be utilized to ensure that the transfers are done properly to avoid triggering tax consequences. For example, a Qualified Domestic Relations Order can be used to ensure that tax deferred retirement savings, such as an IRA or 401k is rolled over from one spouse into a qualified account of the other spouse without taxes being incurred at the time of the rollover. Eventually, when drawn upon in retirement, there will be income taxes due. Of course there are penalties for early withdrawals from these tax deferred saving accounts as well.

There are many other considerations in a divorce, and many other tax scenarios. For more information about different matrimonial and family law topics, in addition to the various processes to handle them such as mediation, litigation, negotiations and collaborative law please click around this blog, our website or call about your free initial consultation. It would be our pleasure to talk to you.