November 18th, 2022
The Intersection of Divorce and Taxes: What You Need to Know
One thing that people in the middle of a divorce don’t realize right away is how intertwined divorce law can be with other areas of law, such as tax, real estate, business, and/or estates and trusts.
It is important to understand how those areas of law could affect your financial circumstances, the disposition or transfer of your assets, and other implications that could stem from your divorce.
At Stein Sperling, we have the unique benefit of attorneys with concentrations in a range of practice areas “under one roof.” Our team of attorneys collaborate with one another when our practice areas intersect.
For example, when it comes to potential tax consequences resulting from a divorce, I can consult with one of our many tax attorneys on complex or novel issues.
One of the tax attorneys I consult with regularly is Eric Rollinger. As a Certified Public Accountant (CPA), Certified Valuation Analyst (CVA), Master Analyst in Financial Forensics (MAFF), and Master of Professional Accountancy (MPA), Eric frequently provides relevant support in the areas of income analysis, tracing, tax consequences of marital awards, corporate structures, business valuation and financial forensics.
I recently presented Eric the “Top Ten” questions that I get asked by my divorcing clients …
1 – Alimony
“My friend was divorced a few years ago and their alimony was deductible to the payor and taxable to the recipient. Is the alimony in my case going to be treated the same? Is there anything that can be included in a divorce or separation agreement to have it treated the same way?”
Eric: No, if the divorce or separation instrument was executed after 12/31/18 then the new law treating alimony as nondeductible by the payor and tax-free to the recipient would apply.
The only people that can have alimony treated the same as before are those who with a divorce or separation instrument executed prior to 12/31/18 who then modify the agreement and chose not to have the new law apply.
2 – Child Support
“If I’m paying child support, shouldn’t I be entitled to claim our child(ren) as a “dependent” on my tax returns?”
Eric: No, just because you are paying child support does not mean you get to claim the child(ren) as a dependent. Only the custodial parent is allowed to claim the child(ren) as a dependent. A Form 8332 can be filed to transfer the dependency exemption to the non-custodial parent.
3 – Child Tax Benefits
“I heard that under the new tax law, there is no longer a tax benefit for dependency exemptions. Why should I still want to be the parent who claims our child(ren) as dependents on my tax returns?”
Eric: The Tax Cuts and Jobs Act (TCJA) does reduce the dependency exemption to $0 on Federal Individual Income Tax Returns for years 2018-2025; however, you still may want to be able to claim the child(ren) as a dependent so as to be able to claim the child tax credit, child and dependent care credit, and state (i.e. Maryland) income tax exemption.
4 – Sale of Marital Home
“We are going to have to sell our home. Are we going to incur additional taxes on the sale?”
Eric: Potentially. If a home is sold for more than its basis, then there is a capital gain. However, if the home has been used and owned as a principal residence for two of the last five years, then there is a possible exemption under IRC Sec. 121 of up to $250,000 each.
5 – Filing Status
“My spouse and I are separated. Can I file my taxes as head of household?”
Eric: Potentially. Pursuant to IRC §7703(b), a Taxpayer may be considered unmarried for filing as head of household purposes if: (1) During the last six months of the tax year, Taxpayer and Spouse have not been a member of the same household (live separate and apart from spouse from July 1st – December 31st of the year), (2) Taxpayer is the custodial parent of a dependent, and (3) Taxpayer pays over half of the expenses of maintaining the household.
6 – Retirement Transfers
“I would like to withdraw some of the retirement funds that my spouse is going to transfer to me as part of our divorce. Will I incur the early withdrawal penalty and will I be taxed at my spouse’s tax rate or my tax rate?”
Eric: Early withdrawal penalties will not apply per See IRC § 72(t)(2)(C) so long as the amount received is from a qualified retirement plan (i.e. 401(k), 403(b) or 457(b), etc.); however, any tax owed would be based on one’s own rate at time of withdrawal.
7 – Monetary Awards
“If I agree to or receive a monetary award as part of my divorce, will I have to pay taxes on that?”
Eric: No, generally speaking monetary awards and transfers of property incident to a divorce are non-taxable per IRC § 1041.
8 – Capital Gains Taxes
“I own a rental property that is in my name alone but because it’s marital property, my spouse is going to get paid a sum of money for the marital interest in the home. If I sell the property, am I going to be stuck with 100% of the capital gains tax since it’s just my name on the deed?”
Eric: A Form 1099 is usually issued to an owner on sale of property, and the IRS has matching software to ensure that the sales price is reported on a Taxpayer’s return. As such, if there are capital gains on sale of home that exceed the 121 exclusion then appropriate arrangements should be made with your spouse to ensure that both spouses report half of the sales proceeds. Another option is to ensure that a tax equalization adjustment is made.
9 – Innocent Spouse Relief
“I’m concerned that my spouse committed tax fraud on prior joint returns. What can I do to protect myself?”
Eric: You can include language in a marital settlement agreement that any tax owed for back tax years will be paid by your spouse. This provides contractual remedies and could also serve as one factor in your favor pursuant to IRC § 6015(f) if you need to obtain innocent spouse relief via filing a Form 8857.
10 – Splitting Joint Tax Refunds
“My spouse and I made substantial estimated tax payments over the last year. How are those tax payments going to be divided if we file separately this year? How can I make sure that I get credited with those tax payments?”
Eric: Joint estimated payments can be divided between the parties in any amount by agreement per Tres. Reg. § 1.6654-2(e)(5)(ii)(A). If no agreement can be made, then the estimated tax payments for the current year must be divided in proportion to each spouse’s current year’s total taxes per Tres. Reg. § 1.6654-2(e)(5)(ii)(B).