The Tax Implications of Divorce

A 2011 Kings County case demonstrates that serious consideration of tax implications is crucial in a divorce. The husband’s gross income was $107,953 and the wife’s was $11,660. After payment of alimony, child support and taxes, the husband took home $41,000 per year and the wife’s income was $58,253.

Be sure to review IRS Publication 504 Divorced and Separated Individuals and discuss the tax implications of a pending divorce settlement with your lawyer and accountant to resolve issues such as:

• Filing separate or joint returns.  Even if you are no longer living together, so long as you are still married on December 31 you can file jointly for that year. This allows you benefit from the marital deduction. However, note that New York treats people who are legally separated as single. If you are concerned that your spouse might be underreporting income or claiming excessive deductions, consider married-filing-separately, even if it results in a higher tax bill.  If you are filing separately, you may file as head of household if, during the tax year, you paid more than half the cost of maintaining a home and a child lived with you for more than half the year.
• Child support.  Child support is not tax deductible by the spouse who pays it and not taxable as income to the recipient. Child support essentially does not exist as far as your 1040 is concerned.
• Alimony.  Absent a stipulation to the contrary, spousal maintenance and court-ordered alimony payments made by written agreement are deductible by the paying spouse and are reported as income by the recipient.
• Claiming dependents. The custodial parent claims the children as dependents unless otherwise agreed to in writing.  If custody is shared equally, dependency of the children may be split, with parents agreeing to claiming the deduction in alternate years, or each claiming a particular child. One child cannot appear on more than one tax return in any one year.
• Transfer of assets from one spouse to the other. There is no tax when property is transferred from one spouse to another in accordance with a divorce or separation agreement. However, the receiving spouse keeps the original cost basis and pays capital gains tax when the property is sold. This may reduce the value of the transfer. However, New York has a $250,000 capital gain exclusion on primary residences that usually softens this blow. If you are transferring retirement plan benefits to your spouse under a qualified domestic relations order (QDRO), there are no tax implications even if the transfer constitutes a premature distribution.
• Preventing fraud. Some people try to defraud their spouses by overstating income on their tax returns and then after the divorce is completed, amending their returns to get the money back. To prevent your spouse from committing fraud, include a clause in your settlement agreement that states that if a tax return is amended, you will get your share of any refund.

The tax implications of your divorce agreement can have a profound effect on your future finances. I have assisted many clients in maximizing their tax benefits and avoiding complications.  Call my office for assistance.