The Double Jeopardy of Divorce and Taxes
A Divorce can be the most devastating event of one’s life. The Tax consequences of it, however, can make the experience far more excruciating! Here are some basic tax facts to consider when planning a Dissolution:
California community property laws generally mandate a 50/50 division of assets and liabilities, including tax liability. When asked, the courts must consider “immediate and specific” tax consequences of taxable events associated with dividing the community property such as a court ordered sale of the family home. However, parties who finalize their property division through settlement negotiations, often have no recourse when they fail to take into account the different tax consequences of divided assets. Imagine the pain and anxiety of a divorcing party who gave up his or her ownership interest in the family home, in exchange for receiving the community retirement benefits, only to find out later that the value of said assets would substantially be reduced by taxes and penalties upon withdrawal!
Generally, California laws do not consider transfers between spouses, when “incident to divorce,” as taxable events and such exchanges are treated as gifts for capital gains purposes. However, the interest portion of the payments on the family home are considered recipient’s taxable income, and in some cases deductible to the payer. Tax professional advice may become necessary if it is not clear whether a transfer is “incident to divorce” according to Internal Revenue Code (IRC). There are also exemptions from property tax reassessment and documentary transfer tax, associated with transfers of real property between former spouses or domestic partners, when pursuant to a dissolution or legal separation judgment.
Under federal law, married taxpayers have the option of filing joint tax returns, but are not mandated to do so. Parties must note, however, that the liability arising from joint filings are “joint and several.” Spousal Support payments, subject to certain statutory requirements of IRC Section 71, are includable in payee spouse’s gross income and deductible by the payer spouse.
The brief overview I have offered here is not intended to be a tax advice, but merely to point out the importance of consulting tax professionals.
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