Tax Planning for Divorce Clients
Attorneys advising clients in marital dissolution matters encounter many
issues that must be negotiated or litigated. Unfortunately, tax planning is
one that is often overlooked.
Settlement Structure
Often, how a negotiated settlement is structured can have an appreciable
impact on one or both parties' tax bottom line. By saving valuable tax
dollars through prudent planning, resources can be used in other ways to
address the needs and expenses of the parties and their children, if any.
The characterization or designation of a payment from one spouse to
another--be it alimony, child support or a property settlement--will have
income tax ramifications for both spouses.
Alimony. The spouse who pays alimony is entitled to an income tax
deduction for payments made, and the spouse who receives alimony must
include those payments in income for the year received. In order to
constitute alimony for federal income tax purposes, the payments must:
- Be made pursuant to a separation agreement or divorce decree that does not specify that the payments are not deductible by the payer
- Be made in cash
- Be paid to, or on behalf of, the payee spouse
- Not be designated as child support
Generally, any obligation to pay alimony
must end on the death of the payee spouse. Furthermore, for the parties to
avail themselves of any tax advantages with regard to alimony for a given
year, the ex-spouses cannot file a joint federal income tax return. Also,
federal tax law prohibits “front-loading” alimony payments.
Child Support. Payments made for child support as provided under a
divorce decree or separation instrument are not tax deductible by the payer
and are not includable in the payee's income.
Property Settlement. As a general rule, property transfers incident
to a divorce do not result in the recognition of a gain or loss on
transferred assets. Instead, the payee spouse is deemed to have received a
gift, and the payer’s basis in the asset is carried over to the payee.
Accordingly, simply dividing assets equally can mean there is a failure to
take advantage of this tax basis rule. Where high-basis and low-basis assets
are available to satisfy a property settlement, using the low-basis assets
can result in lower taxes to the payer on the eventual disposition of the
remaining assets. If the payee is in a relatively lower tax bracket than the
payer, negotiating for a larger property settlement in exchange for that
property being of the lower basis variety may benefit both parties.
Tax Status During the Break-Up Period
The filing status of an individual involved in a divorce or separation
proceeding is determined as of the last day of the tax year. Therefore,
unless an individual has a final divorce decree or other legally binding
final decree, the individual is generally considered married.
Our Firm Stands Ready to Help
You want to negotiate the most advantageous settlement possible for your
client in a marital dissolution matter. Retaining a CPA firm that has
extensive experience with tax issues incident to divorce can prove to be an
invaluable asset to your client. Please
contact us for assistance.
This newsletter is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed, please contact
Steve Riddle,
Tom
Thieme,
Rex Collins or
Doug
Ayres
of our
Litigation & Valuation Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
