It is important to consider taxes when determining the division of property, alimony and child support in a divorce proceeding. If you divide property during marriage or post-divorce, there is generally no tax to either party. However, just because it is tax free, does not mean there are not big tax consequences. The tax basis of property matters as much as its fair market value. If, for example, you were awarded appreciated stocks from your spouse’s account holdings as part of the settlement and later decide to sell, you would be responsible for taxes on the gains, which could be substantial. In a divorce settlement, careful attention to dividing cash, securities, and houses with a mixture of high and low bases will equalize the tax burden so there are no disputes down the road.
Typically, alimony is tax deductible by the payor and included in the recipient’s gross income. Thus, there is a potential conflict brewing between parties over what will be considered property settlement versus alimony. The payor may want a low property settlement and high alimony amounts for the tax deduction. The payee spouse, however, wants the reverse – property settlement not included in income rather than taxable alimony. Being aware of the long-term tax implications when striking a settlement is important.
Child support is tax-free for federal income tax purposes, so the recipients (spouse or child) do not pay taxes on it. However, unlike spousal maintenance, child support payments are not tax-deductible by the parent who makes the payments. Child support must be designated as “child support” in a divorce or separation agreement, instead of lumping it together with alimony or family support. If the agreement is not clear, there can be adverse tax consequences for the recipient of child support payments, because family support or alimony is taxable as income to the recipient.
There are unique tax implications to consider when reaching a fair divorce settlement. For a property settlement, obtain or prepare a schedule of assets with tax considerations for each asset. Understand that alimony is generally taxed as income for the recipient and can be used as a deduction for the payor. Make sure child support payments are clearly separate from other payments to avoid being taxed. Taking the time to evaluate the tax treatment will help you get a fair settlement.
If you are considering divorce, contact the Law Offices of Ronald L. Bell, PC. for help with marital and non-marital property division, spousal maintenance, child support and custody. Call today for help.
Source: Journal of Accountancy, “Tax considerations when dividing property in divorce”, BY Ray A. Knight, CPA, J.D. AND Lee G. Knight, PH.D., accessed January 23, 2015