Divorce and Taxes

By:
Stewart Berger, CPA
Published Date:
Dec 1, 2017

In the United States, there is a divorce every 36 seconds—or about 876,000 per year. The average marriage lasts approximately eight years before a couple gets divorced. Most people who get divorced, however, do not know the tax consequences or ramifications.

Alimony                                

Alimony payments are tax deductible for the former spouse making the payments on page one of IRS Form 1040 and taxable to the former spouse receiving the payment. Payment of the alimony must be required. The payments must be in cash and the spouses, if legally separated under a decree of divorce or separate maintenance, cannot be members of the same household. The Social Security numbers and names of the receiving spouse must be listed if alimony payments for multiple divorces are made. No cash payments to a third party can be deducted as alimony.

If an individual’s alimony payments decrease or terminate during the first three calendar years after the divorce is finalized, the individual paying the alimony might be subject to the recapture rule, which states that he or she must include as income in the third year part of the alimony payments he or she previously deducted. The individual spouse who is paying the alimony can deduct in the third year part of the alimony payments previously included in his or her income.

Reasons for reduction or termination of alimony payments that can trigger the recapture rule include a change in an individual’s divorce or separation document, failure to make timely payments, reduction in an individual’s ability to provide support, and a reduction in the former spouse’s needs.

The recapture rules apply in the third year if the alimony paid decreases by more than $15,000 from the second year or if the alimony  paid in the second and third year decreases significantly from the alimony paid in the first year. Per IRS Publication 504, this rule prevents the front-loading of alimony as a disguised property settlement.

Filing Status

Persons who are legally divorced must file as “single” or “head of household.”

An individual can file as head of household if:

  • The individual and his or her ex-spouse have not lived together during the past six months.
  • The home was the main home for his or her qualifying dependents.
  • The individual paid more than half the cost of keeping up the home for at least half the year.
  • The individual is entitled to claim an exemption for his or her qualifying dependent.

Exemption for Children

The IRS presumes that the custodial parent is entitled to the exemption for his or her children. The custodial parent may trade the exemption to the noncustodial parent by attaching IRS Form 8332 to his or her tax return. Children’s credits are available only to the custodial parent and cannot be traded.

Property Transfers

There is no gain or loss in transferring property during the divorce. Depending on the details of the transaction, a gift tax might be required. The laws of the domiciliary state govern whether an individual has community property.

Separate Property

Separate property is property that each spouse owned before the marriage, money earned while domiciled in a non–community property state, property either spouse received as a gift or inherited separately during the marriage (which is not comingled), property bought with separate funds or acquired in exchange for separate property, and property that a spouse converted from community property to separate property.

Community Property

Community property is property that either spouse or both spouses acquired during the marriage while domiciled in a community property state; salaries, wages, or other pay received for services performed by either spouse or both while domiciled in a community property state; real estate that is treated as community property under the laws of the state where the property is located; and property that cannot be identified as separate property.

Arizona, California Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states.

A prenuptial agreement is a contract between two individuals that governs the distribution of marital assets at the time of the dissolution of the marriage rather than state law.

Gift Tax

Federal gift tax does not apply to most transfers of property between spouses or former spouses that are due to divorce. A transfer of property to a spouse or former spouse is not subject to gift tax if it meets any of the following exceptions:

  • It is made in settlement of marital support rights, and the value of the property transferred is not more than the value of the rights. The transfer does not apply in settlement of dower or curtesy, which are property rights.
  • It qualifies for the marital deduction if the transfer is made before receiving a final decree of divorce or separate maintenance.
  • The transfer is made under a divorce decree.
  • The transfer is made under a written agreement, and the individual is divorced within a specified period.
  • The transfer qualifies for the annual exclusion.

Transfers to a spouse who is not a U. S. citizen is subject to gift tax. Withholding tax is required to be withheld for the nonresident alien spouse at the rate of 30%. The individual must file IRS Form 1042 and follow regulations of remitting the tax. The treaty of the nonresident alien spouse’s country should be checked because most tax treaties exempt alimony payments from withholding tax.

Retirement Benefits

A Qualified Domestic Relations Order, filed as part of a couple’s legal divorce proceeding, governs the tax status of pension and retirement benefits. Benefits transferred to an ex-spouse are taxed as the recipient ex-spouse’s income only when withdrawn. The distribution can be rolled over into an individual IRA owned by the former spouse, and rollover must be made within 60 days of receipt.

IRC section 408(d)(6) allows the division of an IRA without tax consequence to either the IRA owner or the spouse if certain requirements are met. The requirements are as follows:

  • There must be a divorce decree, a decree of separate maintenance, or a written instrument to such decree.
  • There must be a transfer of an interest of the IRA to the spouse or former spouse.
  • The transfer of the IRA must be in an IRA in the name of the former spouse.

The transfer of the IRA can be a specified amount or a percentage of the account.

Social Security Benefits  

Social Security benefits cannot be split as part of a divorce settlement; however, there are provisions under federal law that give former spouses the rights to retirement and survivor benefits under certain circumstances.

A divorced spouse can receive benefits on a former husband’s or wife’s Social Security if the marriage lasted at least 10 years. The divorced spouse must be 62 years of age or older and unmarried. If the spouse has been divorced at least two years, he or she can receive benefits even if the worker is not retired. The worker must have enough credits to qualify for benefits and be of age 62 or older. The amount of benefits received by a divorced spouse has no effect on the amount of benefits a current spouse can receive.

Legal Costs

Taxpayers cannot deduct the legal cost of a divorce. Costs that are deductible are costs attributable to tax advice given by appraisers, actuaries, and accountants.  


berger1Stewart Berger, CPA, is a director in the tax and advisory service Departments of Prager Metis CPAs, LLC. Mr. Berger has over 30 years of accounting experience providing tax and estate services to corporations and high-net-worth individuals. He is also a member of the AICPA and NYSSCPA, in addition to the Society’s Closely Held and S Corporations Committee. Mr. Berger also co-authored a chapter in the Handbook of Budgeting, Sixth Edition published by John Wiley & Sons Inc. He can be reached at sberger@pragermetis.com or 212.643.0099.

 
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