Tax Considerations of Dividing Property in Divorce
20 October 2016IN: Family Law
The property division aspect of divorce is one of the most contentious with both parties diligently trying to protect their own financial interests. In many situations, the parties attempt to have a settlement in which they both walk away with an equal amount of the value of the marital estate. However, if the parties do not carefully consider the tax consequences of their decisions during this process, they may not have the net benefit that they think they do.
One important consideration is to ensure that any property transfers arising out of the divorce are completed in a manner that do not make gift tax liability arise or produce taxable gain. Additionally, the person making the transfer will not want the transfer to be included in his or her taxable estate.
In order to avoid taxable gain, the property transfer must be completed incident to divorce. To qualify under this definition, the transfer must be completed within 12 months from the divorce ate. Alternatively, the transfer must be pursuant to a divorce decree, occurring within six years from the divorce date. This means that the transfer can also be made pursuant to a divorce decree modification.
Additionally, a transfer of marital property rights under a property settlement agreement if it was incorporated into a divorce decree that is not subject to gift tax. The Supreme Court has held that the transfer in this situation would be pursuant to a court decree. If transfers are made after the entry of a divorce decree, this rule may have limited application. However, even if the transfer is not incorporated into a divorce decree, transfer taxes may still be avoided if the transfers are made pursuant to a written agreement and the divorce is entered within two years of the spouses entering into the agreement. In these cases, the transfer does not have to be made within this time period as long as when the transfer does occur it is pursuant to the agreement.
Parties should also be aware of the tax implications of alimony. Alimony is considered a transfer of cash made pursuant to a divorce or separation agreement. The instrument must not designate such payments as child support or anything other than alimony. Additionally, the payments cease at the death of the recipient. The separation or divorce agreement does not preclude a deduction by the spouse making the payments or recognizing the payments as income by the recipient. The spouses cannot be residing in the same household when the transfers are made.
Alimony will no longer be deductible by the person making the payment after 2018. Alimony has historically been deductible to the person making the payment and had to be claimed as income by the recipient.