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Divorce and Taxes
When a couple is getting divorced both current and future tax obligations as well as tax basis are very important. There are four areas that we frequently advise our clients about.
Is Child Support or Spousal Maintenance Taxable as Income?
The new federal tax law does not apply to divorce decrees that were signed prior to January 2, 2019. Spousal maintenance is still deductible for the payor and included as income for the recipient. However, if a divorce decree was entered into after January 2, 2019, spousal maintenance payments are no longer deductible and the recipient no longer has to report the spousal maintenance as income. The Tax Cuts and Jobs Act of 2017 eliminated the spousal maintenance deduction for at least six years from 2019 through 2025.
The recipient of child support does not report any amounts received. This is because child support is considered a non-taxable event. Simply stated, child support received should not be reported on federal or state tax return and the parent paying the support cannot claim it as a tax deduction on either state or federal returns.
Transfers of Property Incident to Divorce
Internal Revenue Code §1041 provides that a transfer between spouses, or former spouses, "incident to divorce" is not taxable in almost all circumstances. Generally, the transfer is treated like a gift. However, the spouse receiving the property takes the other spouse's tax basis in the property. It is vital to discuss the exceptions to the general rule and other pertinent issues relative to tax basis when dividing property with an experienced family law attorney. Although Arizona community property laws require the court to divide the community estate on an equal basis - if tax consequences are not considered when dividing assets - the ultimate division may be far from equal or equitable. A family law attorney should investigate tax implications of any proposed property division.
Child Tax Credit
Starting in 2018, the child tax credit increased to $2,000 per qualifying child. If the credit is going to be claimed, there should be a clear understanding of which parent will claim the credit and whether or not that credit alternates between the parents. Under the new tax laws, the refundable portion is equal to 15% of earned income over $2,500, up to $1,400. In order to qualify for the new credit, all requirements of the Child Tax Credit Test must be met:
1. The child must be under the age of 17
2. The child must be related to you
3. The child must be claimed as a dependent on your federal tax return
4. The child must be a US citizen, US National or US resident alien with a social security number
5. The child must live with you for more than half the year
6. The child must not provide more than half of his or her own support and
7. The child tax credit phases out for married taxpayers filing jointly with an income of $400,000, $200,000 if single
In many marriages, one spouse handles the couple's finances including preparation of joint income tax returns. Even if that is the case, each spouse is jointly liable for tax obligations. A spouse may discover that the other spouse misstated, misrepresented, underreported or simply did not pay their tax liability - either intentionally or inadvertently during their divorce proceedings. While there may be some relief, the spouse who was not at fault will need to meet the requirements of an "innocent spouse" provisions of the Internal Revenue Code. To qualify for relief from obligations, the innocent spouse must establish that:
1. The spouses filed a valid return
2. There was a substantial understatement of tax
3. The understatement was caused by a "grossly erroneous item" attributable to the other spouse
4. In signing the return, the innocent spouse did not know or have reason to know of the substantial understatement and
5. It would be inequitable to hold the innocent spouse liable.
While these are not the only areas that we advise clients about during a divorce, they are the most common. Not getting adequate advice regarding tax implications may cause future problems with the IRS.
About the author: Laurence Hirsch is a family law attorney at the Phoenix law firm of Jaburg Wilk . He has expertise representing high net worth individuals who have closely held businesses in their marital community. He can be reached at 602.248.1000 or email@example.com mailto:firstname.lastname@example.org