What follows is a general summary of tax issues which may be applicable to your divorce. Note that I do not give tax advice, so you should consult with your accountant regarding specific details.
- Spousal Support. Formerly, spousal support was taxable to the recipient and a tax deduction for the person paying the spousal support. But for divorce settlements finalized January 1, 2019, or later, the party paying the spousal support cannot deduct it, and the recipient does not have to claim it as income. This is obviously a big change from what was previously the case.
- Child Support. Child support is not deductible by the person paying the support nor is it taxable to the recipient. Typically, the custodial parent has the right to claim the children as dependents on their tax return, unless there is an agreement (IRS Form 8332), or by Separation Agreement, Consent Order, or Order of the Court. Note that if an Agreement is signed, you need to be very careful because on the IRS form, for example, it has a section where you can make a permanent irrevocable election to allow the non-custodial parent the exemption forever. I never advise anyone to sign a permanent election.
- Property Settlement.
- Cash. It is almost axiomatic that a property settlement in the form of cash is always preferable to installment payments. You want to get the money while you have the chance. Ex-spouses find a number of ways to not live up to the their promises, and while they can be taken back to court and found in contempt, it is best to avoid this exercise.
- Real Property in Retirement. Note that when selling property, if you have a choice between taking a $400,000.00 house or a $400,000.00 retirement plan, take the house. You can sell the house and the proceeds are tax free and keep the entire $400,000.00, whereas, withdrawals from the retirement plan may be taxable at regular tax rates and may even be subject to an added penalty
- Stock and Investments. You also need to be very careful when you accept stocks and investments as part of a property settlement. For example, assume you paid $10,000.00 for a stock or a land investment many years ago and that investment is now worth $250,000.00. if you receive the items as property settlement, you may be subject to paying a capital gains tax on the $240,000.00 gain.
- Marital Status. Your marital status is determined on the last day of the year. As soon as you know your marital status is changing, immediately change your withholding at work from married to single. If you don’t, you may get an unpleasant year-end surprise when you have to pay the government more in taxes.
- Deductibility of Legal Fees. In most situations, attorney’s fees incurred in obtaining a Decree of Divorce or separate maintenance are considered to be personal expenditures and are, therefore, not deductible. As was referenced above, you need to consult with an accountant in regard to specific exceptions to deductibility of legal fees. For example, in some instances, attorneys’ fees expended to obtain taxable income such as spousal support or maintenance may be deductible if the payee’s spouse is able to show how much of his or her legal fees were allocated to the collection of spousal support or maintenance. Legal fees arising out of the enforcement of spousal support or maintenance obligations may also be deductible, but the extent to which these expenses can be deductible, if at all, may be limited.There are several exceptions to the general rule that legal fees are not deductible in the context of marital law. These exceptions usually involve one of the subparts of I.R.C. § 212. The general rule is that a spouse may not deduct attorney fees incurred in connection with a divorce or separation because this matter is considered to be personal and the Internal Revenue Code does not permit the deduction of personal, living, or family expenses. I.R.C. § 262(a).
- (i) Personal Legal Expenses Do Not Qualify. In United States v. Gilmore, a former husband attempted to deduct 80 percent of the legal fees he incurred over two tax years in his bitterly contested divorce. As president and controlling shareholder of three car franchises, he argued that the legal fees were incurred to conserve his income-producing property and protect his business reputation from his wife’s accusations of marital infidelity. The United States Supreme Court held that none of the legal expenses could be deducted, reasoning that it is not appropriate to look at the consequences that might result to the income-producing properties but, rather, at whether the claim originates with the taxpayer’s profit-seeking activities. The Court rules that the taxpayer’s claim “originated” from marital difficulties, which were personal and not business related. This is referred to as the “origin of the claim” doctrine.
- Legal Fees for Spousal support Qualify. Because Section 212(1) allows a deduction for expenses incurred for the production or collection of income, deductions under this provision have been allowed where legal fees were incurred to obtain or increase spousal support. In Wild v. Commissioner, the Tax Court permitted the wife to deduct $6,000.00 out of a $10,000.00 legal bill where the $6,000.00 had been allocated by her attorney as representing the amount attributable to obtaining monthly spousal support payments. A spouse may also deduct legal fees incurred to collect spousal support arrearages. On the reverse side, the party defending against an award or collection of spousal support cannot deduct his or her legal fees. See Hunter v. United States, 219 F.2d 69 (2d Cir. 1955).
- Expenses for Tax Advice Qualify. Section 212(3) permits a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in connection with the determination, collection, or refund of any tax. Tax advice concerning the rights to claim dependency exemptions; characterization and treatment of spousal support obligations; property transfers in connection with divorce; and income, estate, and gift tax consequences to a taxpayer who establishes a trust to discharge the spousal support obligation have all been recognized as permissible deductions to the taxpayer who incurs these expenses. For legal fees incurred in connection with a divorce to be deductible, the attorney must determine what portion of the fee is allocable to tax advice as opposed to nondeductible advice or other services and render an itemized bill.
The above summary is meant to provide you general information which may apply to your case. This is not tax advice. You should consult with your accountant regarding specific details.
Issues Regarding Estates
- Beneficiaries. You need to take the time to check out the listed beneficiary on retirement plans, savings, and any other investments you may have. You will probably want to change those designations.
- New Wills and Powers of Attorney. You will need to change your Wills and Powers of Attorney designating new beneficiaries.
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