Getting a Divorce – A Very Taxing Matter
I have come to the conclusion that the process of going through a divorce can oftentimes be, emotionally, more catastrophic than a death in the immediate family. That’s a statement that is not easy to make, but I believe it is true. Ask anyone who is going through or having gone through a divorce and they will tell you it is or was the most stress they have ever experienced in their lives. I see this stress in the face of many of my clients. Divorce can break a person, plain and simple.
Next to personal bankruptcy its affects on your personal finances will take years to overcome. Most never do overcome the financial wreckage a divorce leaves behind. It is for this reason that anyone contemplating divorce seek out a competent tax advisor to help minimize the financial repercussions of a divorce. A good tax advisor, experienced in divorce tax planning, can better position you to recover from the divorce, financially. There are many pitfalls in divorce tax planning that can be avoided through thoughtful analysis and planning with your professional tax advisor. Anyone contemplating a divorce must meet not only with their attorney but also with their CPA or tax advisor.
I have encountered many instances in my practice where being left out of the planning process resulted in lost tax benefits, typically to the party making payments to their soon-to-be ex-spouse. Additionally, where separation occurs first, there are ways to formulate the separation agreement that enable the payor spouse to receive tax benefits for payments made to the recipient spouse during the period of separation.
In a divorce, there are typically three types of payments that are made between spouses. One is in the form of alimony, another is in the form of property settlements, and the third, if there are minor children, is in the form of child support.
In order for amounts paid by one Tax Advisors spouse to another spouse to be considered deductible, the amounts paid must be pursuant to either a legal separation agreement (called “separate maintenance payments”) or a divorce decree (called “alimony”). In order for separate maintenance payments to be considered deductible, the separation must be considered a legal separation. In a legal separation there needs to be a formal separation agreement and neither spouse may live together in the same home. Additionally, a legal separation requires a court order governing what will happen while the parties are separated.
A legal separation is infinitely more complicated and more expensive than an informal separation. Like a legal separation, a divorce decree must be issued pursuant to a court order. There is a formal agreement setting forth the terms of the divorce. The payments must be made in cash and there is a three-year recapture rule that looks at the dollar amount of the payments made over a three-year period. As an example of this rule, if the payments made in years two and three are lower than the payment made in year one by $15,000 or more, than the year one payment is considered a property settlement and that deduction is recaptured (treated as taxable income to the payor spouse) in year three. Liability for separate maintenance payments or alimony must end upon the death of the recipient spouse.