The beginning of the year is when many think about taxes, but failing to consider tax consequences while negotiating a divorce settlement can be costly. For one, changes to tax laws under the American Taxpayer Relief Act effective in 2013 could affect the amount of tax paid on alimony or spousal support for wealthy individuals. Alimony is deductible to the spouse who pays it, however, the IRS considers it income for the receiving spouse. For 2013, a top tax bracket of 39.6% applies for single filers who have adjusted gross income over $400,000. An alimony award that provides a nice tax deduction may saddle the other former spouse with a lot more taxable income. Child support is tax neutral and does not qualify for a deduction or as income. Characterization at child support or alimony can thus affect the tax burden of each party.
Higher tax on capital gains
The transfer of property from one spouse to another during a divorce is not a taxable event. However, the property retains its original tax basis. For investment assets that have appreciated over the years and will be sold to pay for expenses, consider the applicable capital gains tax.
A 3.8 percent Medicare surtax on capital gains over $200,000 of adjusted gross income applies in 2013. The additional tax burden may justify asking for a larger share of an investment portfolio.
The timing of home sale can also affect taxes. When selling a primary residence the tax code exempts gains up to $250,000 (or $500,000 for joint filers). This comes up when a couple owns a home for many years in a desirable area. It may be better to sell the home in the year of the divorce and take advantage of the $500,000 exemption for joint filers.
Filing status dependent on December 31
When a divorce is not final before December 31, it may make sense to file jointly one last year to minimize the tax impacts. Married filing separate status can mean that some deductions and credits are not available.
If on the other hand, the judge signed a final decree prior to December 31, the filing status is limited to single or head of household. The standard deduction for head of household is higher than for single, but has dependency and housing requirements.
The amount of custodial time affects which parent can claim the child dependency exemption. Often parties will rotate the dependency between even and odd years. With multiple children, one spouse may claim the older child and the other claims the younger child. If the parent with more than 50 percent of the custodial time agrees to give the exemption to the other parent, this must be in writing through an executed IRS form 8332.
An experienced family law attorney will be able to provide more guidance on tax planning in Massachusetts divorce. Forgetting to consider how taxes will cut into a property settlement or alimony award can be costly.
