Divorce & Taxation

More than ever, divorcing couples need strategic tax planning advice. You may not think of it while battling over the house or other property, but proper planning can help ease the financial and tax burden of each divorcee.

During a divorce, assets are distributed based upon certain criteria including when the assets were brought into the marriage, the length of the marriage and the value of the assets. A certified public accountant can assist in all phases of asset valuation. Some critical areas which can be important to asset distribution follow.

Business Valuation

The disposition of your family business will be part of the divorce settlement. Since the business is probably one of family's most valuable assets, it will be critical for you to obtain an accurate valuation of the business for the purposes of an equitable settlement.

A value of a business for a divorce case may differ considerably from it's value for various other purposes. Divorce valuation require special valuation techniques. For instance, discounts applied in the sale of a business to a third party are not applicable in a divorce valuation. In addition, valuing marital goodwill and its impact on future earnings can be crucial to an equitable settlement.

When the value of the business has been established and a settlement has been reached, generally, there is no taxable consequence to either party as the disposition of the business is considered a property settlement.

Pensions

Pension plans generally involve significant increases during a marriage. There are two general types of pension plans - defined benefit and defined contribution.

Defined benefit plans are pension plans whereby an individual is guaranteed a monthly payment upon retirement based upon level of service and salary paid during service. These plans generally do not require an amount contributed by the employee. Defined contribution plans are amount contributed by the employee, the employer or both.

The valuation of these plans is critical within a divorce. Once the fair value is determined, and the settlement is reached, the tax consequences need to be determined.

If a spouse receives a pension distribution as a result of a divorce, the spouse receiving the distribution is not necessarily taxed on the proceeds. The spouse receiving the distribution may transfer the amount into another retirement vehicle and avoid recognizing income. If the amount is not transferred, you will have to pay ordinary income tax on the amount distributed but not the penalty for early distribution.

Marital Status

Your income tax status is determined on the last day of your income tax year, generally December 31st. You are entitled to file separate income tax returns. However, there are very few instances in which filing separately is more advantageous than filing jointly. Most married couples will pay less income tax by filing jointly.

If you meet the requirements of the head of household filing status, you will be allowed several advantages over the married filing separately status. These advantages include, among others, a higher standard deduction, the ability to claim standard deduction regardless of whether your spouse itemizes, and your tax rate may be lower than it would if you had filed married filing separately.

Maintenance and Child Support

Alimony is included in the income of the recipient and deducted from the income of the payer. You do not have to itemize deductions to be able to deduct alimony payments.

Structuring alimony payments is a critical part of your divorce agreement. If not properly structured and if the alimony you pay your ex-spouse decreases sharply during the first three years, you may be forced to recapture a portion of the alimony is income. Conversely, your ex-spouse will be able to deduct the amount of recapture from his or her income.

Child support is not deductible to the payer nor is it included in the income of the recipient.

Residence

The principal residence, if transferred to one spouse, is not a taxable event. However, if the residence is sold, each spouse will have a two-year period with which to reinvest their share of the proceeds in order to avoid taxable gain.

Other issues

Grabau & Company, PC is a certified public accounting firm established in 1990 and located in Denver, Colorado. Please call our offices with any questions you have regarding material in this brochure or if you would like further professional advice on regarding divorce.