Divorce often causes a change in your tax liability. The issues that trigger this change should be addressed as part of a Judgment of Divorce or any agreement between the parties. These tax consequences are important and you must insure that they are considered and discussed in any divorce negotiations. It is impossible to cover all of the tax consequences associated with divorce in this article or address them in the detail necessary to protect your interests. You must see a qualified attorney for a more complete picture of potential tax consequences following your divorce. Contact us online or call (248) 479-6200 for assistance.
A quick summary of some of the more common taxation concerns is provided below.
Common Tax Consequences & Topics
Spousal Support
Spousal support, commonly known as alimony, is generally deductible by the party making the payments and is considered taxable income for the party receiving the payments under sections 71 and 215 of the IRS Code. In order for spousal support payments to qualify as taxable income for the receiving party, and deductible by the paying party, the payments must be in cash, terminate on the death of the payee (under the terms of the governing document), not be designated as child support, and generally, if they are over $15,000 annually, not decline during the first three years following divorce. If the payments are lumped too heavily in the first few years following a divorce, the amount may be subject to a recapture where the payments can be deducted by the payee and taxable on the payer. The use of this provision to a party’s advantage can properly insure that a party falls into a tax bracket where their tax burden is lessened. Furthermore, the statute allows payments that might not otherwise qualify be designated as taxable or deductible. This is incredibly useful to properly situate the parties’ tax liabilities.
It is important to note that child support obligations are not spousal support, and therefore are not considered income and are not deductible. This is money for the benefit of the child and any agreement must be clear as to what the payment is designated for.
Property Transfers
Parties are often concerned of the tax consequences when property is transferred between former spouses as part of the property division. The property transfers between former spouses completed as part of the divorce are not considered income and you will not be taxed on this transfer. This applies to cash, real property, the surrender of marital rights, and the assumption of liabilities.
This right not only applies to transfers made at the time of the divorce, but also those that occur after the divorce when the transfer is made incident to the divorce. Any transfer between former spouses made within six years pursuant to a document of divorce is presumed to have been incident to divorce. After this period it is presumed the transfer was not made incident to divorce, although this presumption can be rebutted.
Sale of a Principal Residence
The tax benefits relating to the sale of a principal residence are transferred from one spouse to the other when the home is transferred as part of the divorce. This is an exclusion on the taxation of the gain from the sale of one’s principal residence for up to $250,000 for a qualified single taxpayer and $500,000 for qualifying married taxpayers filing jointly. The principal residence is plainly the home you live in the majority of the time. In order to claim this benefit a single taxpayer must own and live in the home as their principal residence for two of the last five years preceding the sale. For a married couple one spouse must satisfy the two out of five years ownership requirement and both must have lived in the home for two out of the last five years. This interest, and the spouse’s period of ownership, transfers with any transfer of ownership as part of the divorce. If one spouse stays in the home while it is being sold, this spouse’s use will be attributed to the other spouse.
Legal and Accounting Fees Related to Divorce
While a party may wish to write off the legal and accounting costs related to a divorce, these costs are generally not deductible unless paid for by the spouse to whom the services were provided or paid in an effort to procure taxable income, such as spousal support, if paid by the spouse receiving the taxable income.
Filing Status
A party is often concerned as to what marital status they should indicate on their tax returns. A party who is legally separated or divorced at the end of the year is single for tax filing purposes. If they are still married as of the end of the year they should file jointly or as married taxpayers filing separately. It may advantage a party in terms of tax liability to plan which year they enter the judgment of divorce, if it could be done in one of two years.
Dependency Exemptions of Children in Divorce
The parent with physical custody of the child for more than half the year is automatically entitled to the child exemption on their taxes. However, this exemption can be negotiated for and released to the noncustodial party with IRS Form 8332. Additionally, the courts in the state of Michigan have the authority to award this exemption as part of their ruling.
Qualified Domestic Relations Orders and Eligible Domestic Relations Orders
A Qualified Domestic Relations Order and Eligible Domestic Relations Order is an order that divides pension and retirement accounts. These are complicated and take careful measures to insure they are drafted correctly. It is important that the order be drafted properly to insure that it accounts for survivor benefits, the parties’ rights to early withdraw from the plan, rights to participation in any plan enhancements, and a designation as to who is the death benefit beneficiary.
The tax consequences of a divorce can be complicated and require both financial and legal skills to properly address. If you need assistance with an issue or any questions as to your taxes and how they relate to a divorce please call our office to see how we can help.