By: A.J. Cook


Couples who are splitting had better pay attention to the tax effect, or one or both could wind up with big tax bills.

Developing a tax plan for a divorce requires a careful review of every part of the dissolution agreement and court order. Consider these points:

• Alimony and Child Support. If the payments are child support, neither party gets a deduction nor has income. If alimony, payments may be taxable income to the recipient and deductible by the payor. Tax law looks at the court order and dissolution agreement to see if the payments meet the specific requirements for qualification as alimony. One example: Assume the dissolution agreement provides for payments to the children after the death of the receiving spouse. This fails as alimony for tax purposes, even if the agreement says it's alimony, because the payments don't stop when the receiving spouse dies.
  
• Property Settlement. In dividing assets between divorcing spouses, don't limit your focus on the assets market value, also consider its after-tax value. Generally, when an asset is transferred, the cost basis, which determines future gain or loss, is transferred as well. Suppose a man transfers corporate stock worth $200,000 with a basis of $50,000 to his wife but keeps stock worth $200,000 with a $150,000 basis. With a 20 percent capital gains rate, his later sale triggers a tax of $10,000, but hers, a tax of $30,000.
  
• Retirement Plans and Individual Retirement Accounts. A properly drawn court order is needed to defer taxes and avoid early withdrawal penalties on retirement plan transfers. But with an IRA, taxes and penalties are avoided if the account is transferred to the receiving spouse and the transfer is required by court order or the dissolution agreement. As to either one, if money is paid out, however, the working spouse is generally charged with an early withdrawal penalty and has to pay income taxes on part or all of the amount withdrawn.
  
• Joint Return. A couple still married on the last day of the year may file jointly. But if the divorce is final before December 31, each one files as single. Which results in less taxes varies based on the facts. So if it's workable for your divorce to be granted in either of two years, crunch the numbers. Be forewarned, an ex-spouse can sometimes be held accountable for unpaid taxes shown on a joint return or added later by the IRS, so even if it makes dollars and cents to file jointly, it may not make sense.
  

The Moral:  Divorces can cause splitting headaches.


A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

Copyright © 1987-2001 A.J. Cook All Rights Reserved
This information is not intended for use without professional advise.
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Released 1-8-01