This valuable series on Dividing Property In A Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.
- Major Exceptions to Nonrecognition of Gain or Loss
- Transfers to trust in which property’s liabilities exceed basis.
- Gain is recognized by transferor.
- Gain equals the amount by which property’s liabilities exceed basis.
- Trust increases its’ basis in the transferred property by the amount of gain
- Transfer to Trust of Installment Instrument
- Transferring spouse recognizes untaxed built in gain upon transfer.
- Trust takes carryover basis plus trust gets increase in basis by the amount of gain recognized by transferee.
- Post transfer interest income paid on installment instrument is taxable to trust.
- Example: Transfers to Trust in Which Liabilities Exceed Basis.
Ward and June are in the process of getting a divorce. Ward inherited as separate property, a Japanese Samurai Sword that his grandfather brought back from World War I as a war trophy. The sword has an estimated Fair Market Value of $750,000.
Ward’s basis in the sword is $100,000, and he has pledged it as security for a business loan in the amount of $500,000. As part of the divorce settlement, Ward transfers the sword to a trust for the benefit of June. The trust assumes the loan on the sword. Ward must recognize a gain of $400,000 on transfer calculated as follows:
Divorce is a traumatic event in anyone’s life, and the tax aspects are frequently overlooked, which can add to the distress. The following is an overview of many of the commonly encountered tax issues associated with divorce.
Family Court – All too often, family law courts make rulings that contradict federal tax law, causing confusion and inequities in divorce actions since family court rulings cannot trump federal tax law. A common occurrence is when a family court awards physical custody of a child to one parent and tells the other spouse he or she can claim the child as a dependent. However, federal tax law is very clear that the dependency goes to the custodial parent, regardless of what the family court had to say. However, if this is the arrangement that the divorcing couple actually wants, the custodial parent can provide the noncustodial parent with an IRS form relinquishing the dependency (more on this below).
Help Your Client Help Themselves
If you as a tax professional get the opportunity to advise your client before all the I’s are dotted and T’s crossed at the courthouse, here are some things you can do to help:
1. Based on the desired outcome for child custody, have a Form 8332 already prepared for you clients attorney to present for signature at the time of the court appearance.
2. If there will be a distribution from a qualified retirement account, make sure the QDRO is drawn up in the most tax beneficial manner.
3. If there is to be separate maintenance or support make sure the order is drawn up in the most tax beneficial manner for your client. Read More
There are currently nine states that have community property laws. Every state’s specifics are slightly different, some more or less stringent then others. For the most part, from an income tax standpoint, community property laws mean that anything earned or purchased while the “community” or marriage was intact is split 50/50. This is a big issue in the disposition of property and/or business, which we will discuss later. If you are completing a return either in or for someone in a community property state you should research that state’s specific laws.
When preparing a tax return, some states require that a separately filed return have all Read More
Alimony or separate maintenance is a payment ordered by court decree (not an agreement unsanctioned by the court between parties)(Faylor v Comm’r T.C. Memo. 2013-143) made from one party in a divorce proceeding to the other, in order for the receiving party to maintain a standard of living. (§ Cod. Sec. 215)
We see both sides of this situation all the time, so we must be able to determine if the payments are deductible to the payer and if so they are taxable to the payee. There are several conditions that must be met in order for the tax treatment of the payments to be determined: Read More
The second biggest topic in most divorce cases is child custody and dependent exemptions. Effective 1 Jan 2009, new rules kicked in regarding the necessary documentation for claiming the dependent exemption for a child of divorced or separated parents. Before this date a copy of the judicial decree was sufficient, however, due to the varying nature and ambiguous wording of the different jurisdictions, this was determined to be inadequate. (§ Cod. Sec. 152)
The Form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent), or a facsimile with all the same information, is now required to be Read More
One of today’s saddest statistics is that more than 50% of marriages end in divorce. Divorce effects every aspect of the lives of those involved, from housing, standard of living, family matters, and, of course, all things money. We will cover a number of these topics as they relate to taxes. As with any topic relating to income taxes there are always exceptions to the general rule and all situations should be looked at individually.
Conflicts of Interest
The first thing, as a tax professional, you should be concerned about is making sure you have no conflict of interest in filing a return for a separated or divorced client. Many times, these are long time clients and you must decide if you can ethically continue to prepare returns for both of them now that they have split up. Read More