A divorce comes with many difficult challenges, but those involved also need to consider the tax consequences of the divorce. Tax issues can result from a number of areas. Of course, the parties will no longer be able to use their married status for their tax returns, but the divorce property settlement itself can cause problems if the tax consequences of the settlement are ignored.
A divorce settlement is not considered a taxable event by the IRS. Thus, a transfer between spouses that is “incident to divorce”, as defined by the IRS, will not be treated as a sale. While this may sound great, it also causes many to forget that the property being distributed may be equal in value but not equal for tax purposes. Since it is not considered a taxable event, the person taking the property will have the same “basis” in the property as when initially purchased. When that person sells the property, they will have to pay capital gains tax at the time of the sale on all of the appreciation, even if the appreciation occurred while married. This can cause otherwise equal distributions to be unequal if one person receives property with a lower basis.
The property settlement should also consider the overall taxability of the assets. For instance, if the spouses split the marital property with one spouse receiving appreciated stock and the other receiving the family’s primary residence, then the spouse receiving the stock may have also received the higher tax burden. A sale of appreciated stock would result in a tax debt, but gain from the sale of a primary residence will likely be nontaxable if the home appreciated less than $250,000. The former couple should also consider selling the primary residence if the home has substantially appreciated. The current exemption for appreciation on a home is $250,000 per spouse. So, if the home is likely to be sold in the near future and is likely to appreciate to more than $250,000, then the amount may be tax-free if sold sooner rather than later. If the couple or either spouse has tax liens or debts, then it certainly should be addressed during the property settlement with the help of a tax attorney if your divorce attorney does not have experience in that area.
The couple will have further tax decisions to consider at the time of the divorce. The parties and their divorce attorneys have some control over the taxability of payments between the parties in the form of alimony and child support. While child support payment are not deductible by the payor and are not includible as income by the recipient parent, alimony is deductible by the payor and considered income for the recipient. Therefore, if there is a great disparity in the income tax brackets of the parties, then the parties may wish to consider balancing the payments in consideration. In addition to structuring the payments between alimony and child support, the parties may determine one will benefit more by being able to deduct the children for income tax purposes.
Additional tax issues can result from the couple’s ownership of a business. If stock will need to be sold or redeemed as incident to the divorce then the tax consequences should be considered, particularly regarding which party of the divorce will be considered to have sold or redeemed the interests in the business.
Further, if the divorcing couple has retirement benefits under a qualified plan, the parties must consider whether a Qualified Domestic Relations Order, or QDRO, will be needed to transfer the benefits. The receiving spouse’s benefits, including survivor benefits, will be at risk if this crucial step is skipped, and an improperly drafted QDRO can also have dire tax consequences. Those thinking a do-it-yourself divorce will suffice will surely wish they sought a good divorce lawyer to represent them.
While a divorce is never a pleasant experience, the pain can be lessened by both parties by properly balancing the tax considerations with their distributions of property, ongoing payments, and other tax attributes. Seeking advice regarding the tax aspects of your Maryland divorce can leave you in a much better position for starting your new future.
For addition information regarding the tax consequences of your Maryland divorce, please contact Jeff Rogyom at (410) 929-4578. Please review the Disclaimer page regarding use of this website and its information.