A divorcing couple will be faced with many important decisions and issues including the type of divorce action to pursue, the timing of it, and, of course, a fair division of property. Additionally, there may be child support and alimony to be paid by one spouse. It is important to consider the impact of taxes when looking at a potential property settlement or cash payments. They can greatly affect alimony, child support, property settlements, distributions of retirement benefits and other items you may be addressing in your divorce or separation agreement.
Alimony or separate maintenance is deductible by the paying spouse, and it 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. Another important point about alimony is that you cannot just label a payment as alimony and expect it to be treated as such for tax purposes. A number of requirements must be met. Special rules also prevent alimony deductions from being disguised as property settlements.
Child support payments are not deductible or taxable. As with alimony, merely labeling payments as child support is not enough. Various requirements must be met. Closely related to child support is the issue of who gets to claim the dependency exemption for the child. In general, the exemption goes to the parent who has custody of the child even if the bulk of the child’s support comes from the noncustodial parent. However, the custodial parent can release the exemption to the noncustodial parent.
Property settlements, such as you get the house and your spouse gets stocks, generally are tax-free to both parties. Does that mean taxes are not important in property settlements? Not at all. While the property settlement itself ordinarily is not taxable, who gets 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.
For example, let’s say a house worth $350,000 was purchased a two years ago for $300,000 and $350,000 of stock was purchased 12 years ago for $150,000. The spouse receiving the stock would have a $200,000 gain ($350,000 less basis of $150,000) on an immediate sale, whereas sale of the house would result in only a $50,000 gain ($350,000 less $300,000). Of course, there may be no tax for several years, if both parties plan to hold the assets for some time. Even if you plan to retain assets, you should carefully consider basis when negotiating for specific assets, because circumstances can change and property may have to be sold sooner than you think.
Finally, special considerations come into play when company pension and profit sharing benefits, Keogh plan benefits, and/or IRAs need to be split up. Complications and tax traps can also occur when a jointly owned business will be 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. We would be happy to explore any of the above items in greater detail with you. For more information on this topic, contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
