Divorce Tax Considerations

Implications of Divorce on Your Taxes

New York maintains a court system to peacefully resolve conflicts among its citizens. One of the most popular uses of this conflict-resolution system is divorce. Whether the details of your divorce are settled out of court quickly or litigated for years, the tax consequences cannot be avoided and should not be ignored.

Divorce tax considerations have such a profound effect on divorcing parties that they can dictate many of the major decisions that are made in the course of the process. I have been a New York divorce lawyer for more than 35 years. I bring experience and insight that result in valuable counsel for my clients. My law firm has your back, so you do not make a mistake that lands you in trouble with the Internal Revenue Service.

A Few Basic Tax Considerations

The financial aspects of a divorce settlement or judgment after trial are essentially the product of a rather unique form of "zero sum" negotiation. The object is to achieve the most favorable after-tax result. Many of my divorce clients are surprised to learn about the tax aspects of divorce, and more than a few report problems regarding unfiled income tax returns and suspicions about unreported income. I have helped to unravel more than a few knotty tax problems. Some of the tax issues may include:

Spousal maintenance: The Internal Revenue Code (IRC) can be an important negotiating tool, or a trap for the unskilled and unwary. As defined in Sections 71 and 215 of the code, spousal maintenance payments are deductible by the payor and includable in the income of the recipient. Because of our graduated income tax structure, each dollar paid by a moneyed spouse who is in a higher income tax bracket than a non-moneyed spouse can reduce the payor's taxes by more than they increase the recipient's taxes, provided that you comply with the IRC rules and regulations. If you do not, the payor could lose the deduction and the recipient could receive a windfall.

The dependency exemption: You are entitled to take a $3,400 deduction from income for yourself and each of your dependents. The value of that deduction phases out when your income is more than $150,000. The code has rules that regulate how the deduction may be claimed for children, and it may be the subject of negotiation in a carefully crafted agreement.

Property transfers: There is a $250,000 lifetime exclusion on the transfer of marital residence. Further, the transfer of capital assets - i.e. the marital residence incident to the divorce - should be clearly identified as a tax-free transaction with a stepped up basis.

Filing status: You cannot take the alimony deduction if you and your spouse still reside together. You can, and in most cases, you should file a joint income tax return with your spouse if you are not divorced yet, even if you do not reside together anymore. New York courts may characterize the refund to join in a tax return as marital waste. Statutory amendments (1984) have largely eliminated the so-called "marriage penalty" that makes it less advantageous for two tax payers with the standard deduction to file a joint income tax return.

Filing requirements: If your spouse is paying deductible spousal maintenance, the recipient is required to file estimated income tax returns. My law office does not render income tax advice or prepare income tax returns, but we will alert you to the importance of consulting with your accountant or other tax consultant.

Reporting requirements: In a famous United States Supreme Court opinion, Justice Oliver Wendell Holmes once commented on the tax payer's right to minimize his or her income tax. This is America, and that is true. But there is also a sort of thin blue line that separates so-called "aggressive accounting" from tax fraud. There is no statute of limitations for unreported income. The Schedule C's or business income tax return, which you or your spouse has filed during the marriage, may be a time bomb or the key to an expedient out-of-court settlement. In the divorce case, spouses may often, and spouses often do, argue that the "so-called" executive perks, like the care, credit cards, and cell phone, are really household lifestyle items or "add-backs."

You should have a savvy divorce lawyer who knows that the only income tax return with your spouse's signature on it is the one on file with the Internal Revenue Service, and who knows what to look for. That often requires experience.

The innocent spouse exception: Lore has it that the divorce can be like a hurricane, because you can lose your house. You might face IRC problems and be subject to IRS liens and collection procedures if you have filed jointly with your spouse and there were mistakes or fraud made in the prior tax filings. I can help you understand if you are eligible to obtain the innocent spouse exemption so that you avoid any liability for these potentially costly irregularities.

Especially if you are in a high net worth divorce, these tax implications play a major role in the decisions you will need to make. I have the experience and skill to help you navigate through these complicated tax issues. In my 35 years as an attorney, I have seen many mistakes and permutations, and I know how they play out in the long term.

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