IN DIVORCE, WHO CARRIES THE LARGEST TAX BURDEN?
By Sari M. Friedman, Legal Counsel
Fathers' Rights Association (NYS & Long Island)
There are so many pressing issues in
divorce, who thinks about tax issues? Well, you had better think about it now
especially if you are the paying non-custodial parent.
The IRS determines who is entitled to the dependency exemption and, if
there are no other provisions, they will award it to the
custodial parent. Unfair? Maybe. But you can do something about it.
There is case precedent for asking the Court, in a divorce action, to award
the dependency exemption to the payer, even if he/she is the non-custodial
parent. Burns v. Burns 84 NY 2d 369( Court of Appeals), and Litwack v.
Litwack 237AD 2nd 580 (2nd dept.97) each awarded the dependency exemption
to the non-custodial parent who was the payer.
Parties Can Agree on Who Will Get Exemption
Can parties agree in advance on who will get the exemption regardless of
the IRS rule? Yes, they can. Required simply is a stipulation on who gets
the exemption that would be included in the separation agreement or stipulation
of settlement resolving the divorce action.
There is an IRS form to be executed by the custodial parent that will waive
the exemption either for a specific year, for a specific number of years,
or for all future years. This form, is then attached to the non-custodial
parent's tax return. If, at a future date, the custodial parent refuses
to execute the form, the non-custodial parent can seek enforcement by
Additional Tax considerations
Although child support is tax free to the recipient (and non-deductible
to the payer unless there has been advance agreement to the contrary,
in writing) spousal support, or maintenance as it is usually called, is
tax deductible by the payer and must be declared as taxable income by
the recipient, absent any agreement to the contrary.
How does this affect divorce negotiations and settlements? It is within
the law to maximize maintenance payments and minimize child support payments,
as long as the parties state they are deviating from the child support
guidelines. This is something you might want to consider if the payer
is in a much higher tax bracket than the support recipient To do this,
you must add a clause to your agreement that should there be a future
request for increased child support, the maintenance agreement will be
null and void. The reason is obvious. If the Court modifies the child
support because it is seemingly too low, it could create an unintended
inequitable support arrangement, which the payer should not have to continue
to pay since it was never intended.
Taxes on Property Distribution
Transfers of property between spouses are non-taxable. Similarly, a transfer
of property subject to a divorce or separation agreement or decree, is
non-taxable. However, when the transfer is made, the recipient keeps the
same cost basis amount as the party who transferred the property. That
makes face value of an asset deceiving.
Why, for example, is a $100,000 bank account worth more than $100,000 stock
that was originally purchased for $1,000? Because the latter is subject
to capital gains tax on $99,000 when it is sold, a factor that significantly
reduces its value. The same thing hold true for retirement funds, which
are pre-tax assets and will be tax affected when cashed. Therefore, when
trading assets in a divorce settlement, one must consider the tax consequences
of the asset by examining the asset's true value.
Be sure to
consult with your divorce lawyer about the tax ramifications before making any of these agreements. The
choices you make at the time of agreement can make a big difference later on.