Tax Planning For Divorce

Taxes are typically not a high-priority concern for divorcing couples.
Still, various tax-related issues deserve attention.

Property settlements.

Assets generally can be divided up in connection with a divorce on a tax-free basis. But it’s still important to keep taxes in mind in determining who gets what. Here’s an example. Let’s say Maria and Al’s property settlement calls for Al to receive stock worth $100,000 (originally purchased for $25,000) and Maria to receive $100,000 cash. If Al sells the shares after the divorce for $100,000, he’ll have to report — and potentially pay taxes on — a $75,000 capital gain. Maria, on the other hand, has no tax worries since she received cash.

A qualified domestic relations order (QDRO) is typically required if one spouse is to receive a share of the other spouse’s retirement plan benefits. With a QDRO, the spouse who receives the benefits — not the spouse who earned them — will be responsible for any taxes due when the benefits are paid out.

Personal residence.

If a divorcing couple sells their home while they are still married, they are entitled to exclude up to $500,000 of gain from their taxable income if otherwise eligible for the exclusion. If the ownership of the home is simply transferred to one spouse as part of the divorce settlement, there is no taxable gain or loss at the time of transfer.

However, if the house is sold at a later time, the capital gain exclusion would be capped at $250,000 (unless the selling spouse has remarried).

Alimony vs. child support.

This is an important distinction. Alimony payments are tax deductible and represent taxable income to the recipient. In contrast, child support payments are not deductible and are not included in the recipient’s income. The IRS characterizes payments linked to an event or date relating to a child — such as a high school graduation or a 21st birthday — as child support rather than alimony.

For tax planning assistance in a divorce situation, please contact Lopato & Associates (858) 549-1295

Tax Returns for Smaller Estates

If you’re an estate’s executor or personal representative, you may question whether it’s necessary to file a federal estate-tax return for the estate since the law basically exempts estates worth up to $5.12 million (2012) from tax. But it still may be important to file a return for a married person’s estate, even if the value of the estate is below the otherwise applicable filing threshold.

Why? A return is required for an estate to pass any unused exclusion amount to the decedent’s surviving spouse. This new “portability” provision is currently in place for 2011 and 2012 estates.

Here’s an example of how portability works in very general terms. Let’s say Mom dies in 2012 and leaves her entire $500,000 estate to Dad. The unlimited estate-tax marital deduction reduces her taxable estate to zero, and her estate owes no federal estate tax. Because of the deduction, Mom’s entire $5.12 million exclusion goes unused. But in the future, Dad’s estate may be able to use Mom’s $5.12 million exclusion — as well as his own exclusion — to help protect his estate from tax. To pass Mom’s unused exclusion to Dad, her estate must file an estate-tax return.