It’s not easy to find a benefit in divorce, but there are tax advantages which are beneficial, sometimes only to one spouse, but often to both spouses. There may be other tax benefits or consequences other than those identified below, but these are some of the basics. With that being said both spouses should consult with their own individual accountant to determine the tax consequences associated with their individual situation.
1. Child Support. A spouse receiving child support does not have to pay taxes on this money. It is tax free. This means, the spouse paying child support does not get to deduct this payment. If parties share custody 50/50, both parties may each be able to qualify for head of household status and can adjust the dependency exceptions.
2. Spousal Support. A spouse receiving spousal support pursuant to a written agreement or court order must pay taxes on this money; the spouse paying spousal support receives a tax deduction. It is important for this taxable event to be taken into consideration in the settlement of the entire case. Also, if agreed between the spouses, the settlement agreement can structure the spousal support as a non-taxable event thereby allowing for more flexible tax planning. If parties litigate their matter and allow a judge to decide the issue, the spousal support paid will be taxable to the recipient and deductible by the payor.
3. Property Division. Property transferred between spouses in connection with their divorce is a tax-free event. However, it is important to know the tax basis and hidden future taxes associated with an asset which is awarded to each party in the divorce. Special attention needs to be paid the capital gain exclusion rules associated with the family residence.
4. Attorney’s Fees. Generally, fees charged by attorneys, accountants, appraisers and other experts in connection with the marriage dissolution, child custody and similar family law disputes are not deductible by either party because they are considered personal expenses. However, if these expenses are incurred to obtain taxable income, such as establishing taxable spousal support, a modification proceeding or negotiation to increase spousal support, or to resist a decrease in spousal support, then the legal fees are deductible. Other examples of fees incurred to obtain taxable income are:
- Cost of obtaining an interest in the other spouse’s pension or profit-sharing plan (including the preparation of a Qualified Domestic Relations Order which divides the retirement plan), since distributions from the plan will be taxable when received;
- Cost of obtaining other assets that will be taxable when received (such as a portion of an author’s royalties in a community property work);
- Costs of properly structuring a property division to produce desired tax effects;
- Costs to determine the adjusted basis of assets which are to be distributed in the divorce settlement;
- Costs of planning an alimony trust or annuity agreement;
- Costs of estate planning which relate to assuring property estate and gift tax consequences;
- Costs to prepare a written agreement to assure deductible support payments;
- Costs for maximizing the deductible portion of spousal support or of minimizing the taxable portion of spousal support;
- Costs of allocating dependency exemptions;
- Costs to assure either or both spouses can secure rollover treatment for the sale of the residence in connection with the divorce; and
- Costs of obtaining advice about the tax consequences of a divorce or separation instrument.
These are complex accounting rules which require the advice and guidance of an accountant to determine how to implement these rules in your particular situation. Every party to a divorce should inquire of their accountant and their family law attorney about how to make their tax season a little bit brighter.