In the heat of negotiations, it’s easy to overlook details such as tax issues, in hammering out your divorce settlement. The following is a list of common the tax issues to consider and discuss with your lawyer or tax advisor before finalizing the terms of your agreement. While not always possible in a litigated divorce, in a mediated or collaborative divorce you have the opportunity to fine tune your agreement to minimize the overall tax burden and maximize the resources of the family.
1. Real Estate Issues: While you need substantial capital gains before the equity from the sale of your home would be taxable, you may want to consider other tax issues related to real estate such as who will get the benefit of the deductions for mortgage interest and taxes for the final year of your marriage. If you have rental property, the obligation and right to claim income and deductions relating to the rental property should be addressed as well.
2. Income from Investments: If you are not filing a joint income tax return for the final year of your marriage, you may want to consider how income from investments will be claimed on tax returns.
3. Asset Division: While the transfer of assets from one party to another incident to a divorce is generally not a taxable transaction, not all assets are equal with respect to their tax consequences. Assets outside of retirement accounts may have capital gains or losses associated with them. Life insurance with a cash value may have a portion that is taxable if the policy is cashed. Assets inside of a retirement account such as a 401k or IRA have not yet been taxed and are not equal to assets outside of a retirement account. The after-tax value of your assets should be considered in structuring an equitable asset division.
4. Child Support and Alimony/Maintenance: Child support payments are not tax deductible and are not taxable as income. The recent tax law changes now provide that alimony payments included in judgments entered after 12/31/18 are not tax deductible or taxable as income. There are still tax credits that are available with respect to dependent children however, that may be worth evaluating and considering in negotiating your settlement.
5. Losses Carried Forward: If you have losses carried forward on jointly filed income tax returns, consider whether these should be allocated equitably between each party going forward after the divorce. These losses can help to reduce your tax burden in the future.
6. Tax Return for Final Year of Marriage: Your status on December 31st (married or single) determines how you will file your tax return for the entire year. In some circumstances it is possible to schedule the date of your divorce judgment to fall either before or after December 31st so that you may make the most economical decision with respect to your filing status during the final year of your marriage.
Your situation is unique and tax laws are subject to change. It’s important to confer with your lawyer and tax advisor as you negotiate the terms of your divorce settlement.