If you are facing a divorce or legal separation there are several tax concerns that should be addressed to ensure that tax costs are kept to a minimum and that important tax-related decisions are properly made.
Support provisions. Where one spouse is to be making support payments to the other upon divorce or separation, the payments are deductible by the payor and taxable to the payee if they qualify under the tax rules for “alimony.” To qualify, the payments must (i) be required under the divorce decree or separation agreement (i.e., voluntary or “extra” payments won’t qualify), (ii) be in cash only (not goods or services), and (iii) be required to end at the death of the recipient spouse. Also, (iv) the parties must be living in separate households. The parties can elect to have payments that qualify be treated as not qualifying (but not vice versa).
Tax planning for support payments generally seeks to make them deductible if the paying spouse is in a higher tax bracket than the recipient, as is often the case. The tax savings for the paying spouse can be shared with the recipient through higher payment amounts or other benefit provisions.
Dependency exemptions. To some extent, the parties can determine who is entitled to claim the dependency exemption for their dependent children. The exemption for the child goes to the spouse who has legal custody of the child. However, that spouse can waive his or her right to the exemption, thus allowing the noncustodial spouse to claim. If you waive your right to the exemption, you must file a form with your tax return waiving your right to the exemption. There are many other rules for dependency exemptions. Keep these in mind when contemplating a divorce or drafting a property settlement agreement.
Property settlements. When property is split up in connection with a divorce, there are usually no immediate tax consequences. Thus, property transferred between the spouses won’t result in taxable gain or loss to the transferring spouse. Instead, the receiving spouse takes the same basis (cost) in the property that the transferring spouse had. The receiving spouse may have to pay tax later, however, when the recipient spouse sells the property. There are special provisions on the tax free transfer of property incident to a divorce or property settlement agreement. Special tax rules apply to certain categories of property. Make sure you get professional advice in the best arrangements for transferring your home, pension benefits, and certain business interest.
The above mentioned issues are only a few of the taxation problems relating to a divorce or separation.
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