Divorce can be a stressful time and tax consequences are often overlooked during the adversarial process. Divorce settlements often require the division of assets, accounts, property and payment of alimony. Although all of these assets can be taxed in a divorce settlement, it is possible to structure the settlement in a way that avoids tax liability.
Division of Assets
When dividing financial assets, an agreement must be reached as to how much money each party will receive. The transfer of assets between married partners is neither taxable nor tax-deductible. Therefore, it is crucial that all assets be transferred before the divorce is finalised.
Division of Accounts
All 401K, IRA, CD and investment accounts have a tax basis (the value of the original amount). Generally, any gains realised on these accounts are taxable. Whoever retains ownership of the account will owe capital gains taxes on the earnings upon withdrawal.
Division of Property
Married couples can exempt up to £162,500 per person in capital gains tax when a primary residence is sold. If the home is sold prior to a divorce being finalised, up to £325,000 of the capital gains are tax-free; however, if the home is sold after the divorce is final, only £162,500 in capital gains can be deducted by the recipient. For businesses, division is considered by adjusting the expected tax gains out of the valuation and equally dividing the amount that would remain after taxes.
Alimony is generally tax-deductible to the spouse making the payments and is regarded as taxable income to the recipient. As a rule, if this payment is set to end upon the recipient’s death, it is taxable. If the payment must continue regardless of death, as in a lump-sum alimony settlement, the payment is not taxed. One way lawyers structure this as a tax-free settlement is to demand a lump sum, but if the payer is unable to make a single payment, an instalment plan is negotiated and the recipient receives the money tax-free over time.
One thing is certain in divorce settlements – child support payments are never considered taxable income to the recipient and are never deductible to the person paying the child support.