Looming in the background of any transaction involving property is the question of tax consequences. This will be another one of those areas where you will need to seek professional expert help to get a complete answer. Here, I will give you a short break down of some common issues.
Pension Plans and 401Ks: Will you be splitting a retirement plan or a 401K, accepting a lump sum payment, or sharing in actual payments upon reaching retirement age? Each option has different tax consequences. Will a QDRO (qualified domestic relations order) be needed in order to protect yourself from incurring taxes that should be the responsibility of your ex-spouse? The answer is probably yes. Frequently the preparation of a QDRO is a task that your lawyer will “farm-out” to a specialist.
IRAs: Some IRAs provide income that is not taxable. The distributions from other types of IRAs, 401Ks, and from all pension plans will be at least partly taxable.
Child support: It will not be includable in gross income for the recipient, and not deductible for the payer.
Spousal maintenance: No matter if you qualified for the limited version in the Family Code, or agreed to it as part of your settlement. Either way, the maintenance payments will be deductible for the payer and includable in gross income for the recipient. However, be aware that the IRS looks very closely at whether maintenance is truly spousal maintenance (alimony) or child support in disguise. No matter what you call the payment in your divorce decree, the IRS will decide based on the actual nature of the transaction and payments.
The marital residence: The IRS allows a homeowner to sell a home and buy a new residence within a certain time period without paying capital gains tax. You need to find out if you fit the criteria.
Business buy-out: Properly valuing a business (as discussed above) is only the first step. How the buy-out is structured will determine whether it is taxable at the ordinary income rate or the lower capital gains rate. In cases where both spouses are shareholders or partners and one buys out the other through the divorce settlement, there are usually no income tax ramifications. Your lawyer needs to make sure that no language in the agreement results in a tax liability to the spouse who is selling his or her interest in the business to the other spouse.
Keeping your eye on the “after-tax” outcome of your settlement agreement is very important in ensuring that you get a good deal. No matter how you structure it, or how good a deal looks on paper, you will ultimately have to pay the Feds their share. You and your lawyer should strategize ways to minimize the IRS’s cut, and what effect tax consequences will have on you and your soon-to-be-ex’s relative bargaining positions. You may be surprised at what the two of you can agree to, when there are tax benefits involved.
Parting Words
As I said from the start, each case will be very different. I do not attempt here to give you “legal advice” on your particular case. I merely hoped to give you background information on some common financial issues that arise in divorce cases. I will close with the only piece of legal advice I feel comfortable giving: get yourself a good lawyer. You won’t regret it.