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Divorce- Some General tax Considerations

 

A divorcing couple will be faced with many important decisions and issues ranging from the type of divorce action to pursue, the timing of it, and, of course, a fair division of property and possibly payment of alimony and child support by one spouse. Even though this may be the least of your concerns at the moment, you should be aware of the relevant tax laws. They can greatly affect alimony, child support, property settlements, distributions of retirement benefits and other items that you may be addressing in your divorce or separation agreement.

 

For any divorce or separation instruments executed before January 1, 2019, alimony or separate maintenance is deductible by the paying spouse and is taxed to the payee spouse unless both agree that it will be tax-free to the recipient and nondeductible by the payer. A spouse may agree to give up the deduction if it would be of little or no value, such as where he or she has deductible tax losses from other sources.

 

However, the deduction of alimony and separate maintenance payments by a payor, and the inclusion of the payments in gross income by the payee are generally repealed for any divorce or separation instruments:

• executed after December 31, 2018; and
• executed before January 1, 2019, and modified after 2018 provided that the modification expressly provides that the repeal of the qualified alimony and separate maintenance rules apply.

 

For any divorce or instrument not affected by the repeal, alimony rules are intended to provide an objective standard for determining what constitutes alimony for federal tax purposes. These rules also permit the parties to designate payments as non-alimony in their divorce or separation instrument. These rules apply only if the payments are made in cash under a divorce or separation agreement that does not require continuation or substitution of payments after the payee’s death. The spouses must be legally separated, must not file a joint return, and must not be members of the same household.

 

Payments that a divorce or separation instrument fixes as payable to support the payor’s child or noncash property settlements are not considered qualified alimony or separate maintenance payments. Child support payments are neither deductible nor taxable. Merely labeling payments as child support is not enough. As with alimony, various requirements must be met.

 

Closely related to child support is the issue of who gets to claim the child as a dependent. In general, it goes to the parent who has custody of the child, even if the bulk of the child's support comes from the noncustodial parent. Although the deduction for personal and dependency exemptions is temporarily repealed for tax years 2018 through 2025, the definition of a dependent is still applicable for other tax benefits. The custodial parent can release the “exemption” to the noncustodial parent. This release of the exemption allows the noncustodial parent to claim the child tax credit and the additional child tax credit (if either applies).

 

Property settlements, such as the home and investments, generally are tax-free to both parties. While the property settlement itself ordinarily is not taxable, who receives what property can greatly affect either spouse's potential future taxes if the property received is later sold. This is because of the rules regarding basis, which is the yardstick for measuring tax gain or loss when you sell an item.

 

Finally, special considerations come into play when there are pension and profit-sharing benefits, Keogh plan benefits, and/or IRAs to split up. Complications and tax traps may also occur when a jointly-owned business is transferred to one spouse in connection with a divorce.

 

As you can see, taxes can and do play a very important role in shaping a divorce agreement. Please contact our offices if you would like greater detail related to any of the above items.