Divorce issues & tax tips

1. Non-recognition rules of property settlement between spouses. There is no gain or loss recognized on a transfer of property incident to a divorce under IRC section 1041.

Sample 1

Toni receives payments from her ex-husband in return for her agreement to abandon her claim to ex-husband’s retirement benefits. The payments are for the transfer of property to release Toni’s share of the benefits incident to the couple’s divorce. Toni will not include payments in her income.

2. Exceptions to non-recognition rules of property settlement between spouses include: former spouse is a nonresident alien, some transfers in trust, and stock redemptions under a divorce that are taxable under applicable tax law.

3. Qualified Domestic Relations Order or QDRO. Benefits issued from a qualified retirement plans such as defined benefit plans, profit sharing 401k plans, etc under a QDRO are taxed to the non-participating spouse who received it. It is not subject to 10% early withdrawal penalty and no effect on the participant in the retirement plan. The funds must be distributed directly to the non-participating spouse. The non-participant spouse can receive the distribution under the QDRO through direct rollover into an individual retirement account IRA. To avoid the 20% withholding rule, a direct trustee-to-trustee transfer may also be considered. Following distributions from an IRA could be subject to a 10% penalty failure to meet the requirements.

4. Individual Retirement Account or IRA. QDRO is not applicable to IRA. If the divorce final decree is issued before the end of the taxable year, allowed contribution deduction is only the portion you contributed for your own traditional IRA.

5. Alimony paid prior to the final divorce decree is non-deductible.

6. To contribute for an IRA you must receive compensation. Compensation includes alimony. Those who receive taxable alimony may treat the alimony as compensation even if it is the only income they have, it allows them to save for their retirement by making either Traditional or Roth IRA contributions under Code Sec. 219(f)(1)).

7. Costs associated with divorce. Court cost and legal fees for getting a divorce are non-deductible. The spouse required to pay legal fees of his spouse related to the divorce are non-deductible unless deductible alimony requirements are met.

8. Spousal buy-out debt. A spouse refinances to buy out the other spouse. The secured debt incurred to buy out other spouse’s interest in a home, is acquisition debt.   May deduct 100% home mortgage interest up to the $1 million acquisition debt or grandfathered debt limit plus interest on equity debt up to the $100K limit. The equity debt interest is not deductible for AMT purposes.

9. Your legal marital status is determined as of December 31 of each year.  Even if you were married for the previous 364 days if you were divorced on the 365th day of the year, you are considered unmarried for the entire year.

10. Legal marital status is determined upon issuance of divorce final decree on or before end of that year.  If you do not receive a decree by the end of the year, you cannot file as single taxpayer. A couple living under a legal separation agreement but without any court decree is not legally separated for tax purposes because such an agreement could be abrogated by the parties upon reconciliation and resump11. You may file as head of household to take advantage of lower tax rates if you paid more than half the costs of maintaining your home for your child (provided your spouse did not live with you from July 1 to December 31) and may claim the standard deduction even if the other spouse itemizes on a separate return.

12. If the divorce decree does not specify who is entitled to the dependency exemption, the parent with the custody for the greater part of the year gets it. The non-custodial spouse must attach Form 8332 to the tax returns. Form 8332 is a written declaration of release of claim of the child as depended to the non-custodial parent. Non-custodial parent may ask the custodial spouse to sign Form 8332 for all future years or for only specified years.

Disclaimer: Any accounting, business or tax advice contained in this communication is neither intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

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Al-os & Associates Accountancy Corporation provide accounting and tax services to individuals, corporations, LLCs and business entities. The Firm has a niche in defending taxpayers audited by the IRS and other governmental agencies. The former firm Sy Accountancy Corporation celebrated its 37th anniversary in 2014 and Al-os & Associates Accountancy celebrated its 2nd anniversary in 2016 as a transitioning firm. 


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