While tax considerations will rarely be the driving force behind divorce negotiations, the income tax implications of potential resolutions with regard to spousal support and property distribution can be significant for both spouses. A strategic approach that takes these implications into consideration cannot only mitigate the tax consequences of a divorce, but it can also open up new opportunities for resolution that might otherwise go unexplored.
Conversely, failing to consider the tax consequences of a divorce settlement can lead to undesirable and unexpected consequences. For example, the following are seven tax issues that have the potential to have a significant impact on a California divorce:
Avoiding Undesirable and Unexpected Tax Consequences During Your Divorce
1. Tax Consequences of Alimony
Under the alimony provisions of the Tax Cuts and Jobs Act, spousal support payments will no longer be deductible for divorces finalized after December 31, 2018. This eliminates a significant incentive for high-earning spouses to agree to spousal support during divorce negotiations. However, since former spouses who receive alimony will no longer be required to report their payments as taxable income, alimony is likely to continue to play a central role in many divorce negotiations.
2. Income Tax Liability for Taxable Transfers
While most property transfers between spouses during a divorce are exempt from the income recognition principles that apply under other circumstances, certain types of transactions can still trigger income tax liability. Typically, it will be in both spouses’ best interests to avoid transfers that would result in unnecessary liability to the California Franchise Tax Board or the IRS.
3. Child and Non-Child Dependent Tax Credits
While the Tax Cuts and Jobs Act is eliminating personal exemptions for dependents through 2025, it is increasing the child tax credit from $1,000 to $2,000, and it will create a new $500 credit for non-child dependents. Parents will want to factor these credits into their divorce negotiations to ensure appropriate calculation of all financial support obligations.
4. Qualified Domestic Relations Orders (QDROs) for Retirement Plans
In order to avoid adverse tax consequences as the result of splitting a retirement plan in a divorce, it is necessary for the parties to obtain a qualified domestic relations order (QDRO). A QDRO is not necessary to divide an IRA or a non-retirement investment account; however, there are still important tax considerations for these accounts as well.
5. Income Tax Implications for Business Valuations
With its reduced income tax rates for corporations and pass-through business entities, the Tax Cuts and Jobs Act is also expected to have a significant impact on business valuations. With businesses potentially being valued higher due to improved cash flow, business owners and their spouses need to be sure that they apply current valuation standards during the divorce process.
6. Mortgage and Home Equity Deductions
In addition to dividing their community assets, divorcing spouses in California must also divide their shared debts. When assessing the viability of assuming personal responsibility for a debt during a divorce, it is important to consider any tax credits or deductions that may be available. Of course, these credits and deductions can change, and this is yet another way that the Tax Cuts and Jobs Act will affect divorcing spouses in California.
7. Filing Status
If you do not finalize your divorce before the end of the year (which is not possible with California’s six-month waiting period if you file on or after July 1), you will have the option to file a joint return or check the box for “married filing separately.” While filing jointly can reduce your tax liability, it can also expose you to liability for errors and omissions made by your spouse. Additionally, your child custody negotiations will determine if you are eligible to file as a “head of household” after your divorce, and this can have significant tax consequences as well.
Contact the Law Office of Renkin & Associates in North County, CA
If you would like more information about the tax implications of divorce in California, we invite you to contact us for a confidential initial consultation. To request an appointment with North County divorce attorney and Certified Family Law Specialist Richard M. Renkin, please call 619-299-7100 or inquire online today. The firm has two offices for your convenience in Downtown San Diego and Encinitas.