Divorce Tax Planning

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In August 2012, Tiger Woods and Elin Nordegen finalized their divorce here in Florida. With their settlement terms undisclosed, the world is speculating as to what will happen with the young billionaire’s assets, including the family mansion in Isleworth.

Whatever the settlement may be, you can be certain that for Tiger and Elin, as for all high net-worth clients, tax considerations are paramount in their final settlement.  Important tax considerations in divorce planning include the following:

  • The Alimony Deduction.  Settlement terms that don’t take into consideration all of the requirements of alimony set forth under Internal Revenue Code §71 could result in a denial of tax deductions for the payments – deductions which could be substantial in the short and/or long-term.
  • Claiming Dependents. Unless otherwise agreed to in a settlement agreement, the childcare deduction goes to the custodial parent.  If custody is split 50/50, arrangements can be made whereby each parent claims a different child on their return (assuming they have more than one), or each parent claims one-half of the deduction for each child.  
  • Tax-Free Transfers. Transfers between spouses are tax-free under IRC section 1041(a) only if they are incident to divorce – this means that the transfer occurred within one year of the termination of the marriage. Transfers made for the following six years are also considered incident to divorce if made pursuant to a divorce or separation agreement.
  • Carryover Basis.  If you receive an asset incident to divorce, although there is no tax at the time of the transfer, you receive a carryover basis in that asset. This means that if it was purchased at $1,000 and is now valued at $10,000, if you sell it you will have to pay tax on the $9,000 appreciation.  This obviously reduces the value of the transfer and is why cash is worth more than appreciated investments for divorce settlement purposes.

Divorce is a major financial undertaking and it is crucial that you have a divorce lawyer who is well versed in the tax ramifications of divorce.

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