.jpg)
By Dyan M. Kozaczka, Partner
Many couples involved in a divorce are confused about its impact on their individual income taxes and how the divorce may trigger tax liabilities. During and after your divorce, you will want to discuss some of these factors with your tax advisors:
Alimony: Alimony is no longer taxable to the recipient or tax-deductible to the payor. Alimony calculations for those divorced after January 1, 2019, are more complicated than they used to be. That is because today’s orders are often based on the taxpayer's net income. This allows each spouse to be treated fairly, but it often requires a true-up after the individual has filed his or her tax returns. By contrast, for divorces finalized before January 1, 2019, alimony payments were typically deductible for the payor and taxable to the recipient. This made alimony orders based on a percentage of gross income easy to calculate.
Asset transfers: Assets transferred from one spouse to another due to a divorce judgment typically do not trigger a tax obligation.
Embedded taxes: Although an asset transfer may not trigger a tax liability, it is important to determine if assets have embedded tax obligations when deciding on a property settlement. For example, $100,000 in a savings account may not be equal to $100,000 in a brokerage account. The cost basis of the investments in a brokerage account may be less than the current value. Therefore, if liquidated, taxes would be triggered.
Retirement accounts: Not all retirement accounts are created equal. There is a major difference between a 401(k) and a ROTH 401(k). In a 401(k), you do pay taxes on funds as they are distributed because you make pre-tax contributions. In a ROTH 401(k), you do not pay taxes when funds are distributed under the current tax code because you make after-tax contributions. Therefore, $100,000 in a ROTH 401(k) is much more valuable than $100,000 in a 401(k).
Dividing a 401(k) can be accomplished with a qualified domestic relations order (“QDRO”). A QDRO allows a retirement account, or a portion of one, to be transferred from one spouse to another without triggering a tax liability or incurring an early withdrawal penalty. IRAs can be similarly transferred without a tax liability or withdrawal penalty by an IRA-to-IRA transfer in accordance with a divorce settlement. Such a transfer is usually accomplished by filling out a simple form, and a QDRO is not necessary.
Assets sold at dissolution: It is important to determine if the sale of an asset will trigger a taxable event and who will be responsible for payment. If a principal residence is sold in connection with a divorce, it may trigger a significant capital gains liability. An experienced family law lawyer and accountant can assist with determining the best timing and approach.
Potential liability for joint returns: Married couples often file joint tax returns, for which each spouse is jointly and severally liable. It is possible that a tax return filed while married can be audited after the date of dissolution. It is important to address how a potential refund or liability will be handled in a separation agreement.
Child Credits: Recently, Child Tax Credits have replaced the dependency exemption. It is important to determine who qualifies for the child tax credit, and if both parents qualify, the separation agreement should state which parent is allowed to claim the credit each year.
While this does not provide tax advice, these issues often arise during a divorce. It is important to discuss these issues with your tax advisor.
***
Dyan Kozaczka is a partner at Siegel, Colin & Kaufman who was recognized for inclusion in the 30th edition of The Best Lawyers in America® in the field of Family Law in Stamford. She has extensive experience settling and litigating highly complex financial matters and handling family law appeals. Dyan often collaborates with financial experts to analyze and determine the value of interests in private equity funds, professional practices, and privately held business interests. Contact her for help with questions about divorce, alimony, child support, property division, mediation, arbitration, and post-judgment motions for modification and contempt. Contact Dyan in the Stamford office at (203) 326-5145 or by email to schedule a consultation.