• 26
  • September
    2011

When you are approaching a final divorce settlement, taxes may be the farthest thing from your mind. Many splitting couples simply want to wrap things up and move on with their lives. Yet, while this feeling is understandable, it does not mean that you should overlook tax consequences which can have a significant impact on your finances. If you are working through a divorce, you should be aware of some essential information well before tax season comes around.

Alimony and Child Support

Alimony is a payment made to a former spouse under the terms of a divorce decree or agreement. Alimony is deductible by the payer, whether or not deductions are itemized. To be deductible under the tax code, alimony must be paid in cash, may not be treated as child support or designated as something other than alimony in the divorce instrument and the former spouses cannot file a joint return or be members of the same household when payments are made.

In addition to being deductible by the payer, alimony is considered income for the recipient and it is thus subject to income tax. Child support, on the other hand, is neither deductible by the payer nor income to the recipient.

Retirement Accounts

Retirement funds can inspire complex tax questions in a divorce. When early distributions are made from a retirement plan, they are normally subject to a 10 percent tax penalty in addition to any ordinary income taxes. However, if a Qualified Domestic Relations Order is used to transfer retirement funds to a former spouse pursuant to a divorce settlement, the 10 percent penalty may be avoided, although income taxes will still be withheld. The transfer will be tax-free if it is made directly to another retirement account, such as the former spouse's own IRA.

Tax Considerations of Property Division

Generally, the transfer of property incident to a divorce is not a taxable event. Even so, when planning property division in a divorce settlement, you should carefully consider potential tax consequences.

For instance, capital gains taxes apply to assets that have appreciated in value (e.g., you purchase a piece of land for $10,000, and sell it for $25,000; you have $15,000 in "gain" that is subject to a capital gains tax). Thus, because they have different cost bases, two pieces of property that have an equal market value may actually be worth different amounts when accounting for capital gains taxes.

Tax Rules Pertaining To Divorce Can Be Complex

Most tax rules come with a variety of exceptions, caveats and loopholes. While it is extremely beneficial to have a basic understanding of how taxes will come into play in your divorce settlement, it is also essential to seek the advice of a qualified professional.