Because the facts of every circumstance is different, it is vital to consult with an attorney regarding any particular circumstance. However, this summary does help provide some important information on this topic.
1. Numerous common tax issues:
a. Joint Tax Returns: Divorced spouses may not file joint tax returns. Marital status for filing purposes is determined on the last day of the year. 26 USCA § 7703(a)(1).
b. Child Support: Generally, child support payments are not included in the income of the recipient spouse and are not deductible from the income of the payor spouse.
(1) Relevant Case Law:
Thorp v. Thorp, 390 S.W.3d 871 (Mo. App. 2013): The trial court’s order requiring father to pay more in child support each month after he was awarded the dependent tax exemption. Over the course of a year, the father would pay $1,092 more in child support while recognizing a $3,800 tax exemption. Note: Tax exemptions are or may be a relevant factor in determining the money available to pay child support obligations
Jeffus v. Jeffus, 375 S.W.3d 862 (Mo. App. 2012): The trial court’s award to husband of federal dependency exemptions for minor children did not preclude offsetting wife’s dependent care expenses with a federal tax credit, in calculation of child support award in favor of wife. This award was consistent with federal law.
Scobee ex rel. Roberts v. Scobee, 360 S.W.3d 336 (Mo. App. 2012): A trial court has broad discretion in awarding tax dependency deductions and abuses that discretion only when its ruling is clearly against the logic of the circumstances before the court and is so unreasonable and arbitrary that it shocks the sense of justice and indicates a lack of careful, deliberate consideration.
Basham v. Williams, 239 S.W.3d 717 (Mo. App. 2007): In the absence of an agreement between the parties in a child support proceeding, it is appropriate for the trial court to determine and express which party is entitled to the available income tax dependency exemptions; the power, however, must be exercised in accordance with the provisions of the Internal Revenue Code. Note: the court cannot simply order that a noncustodial parent receive a child as a dependent for income tax purposes. The court must order the custodial parent to execute a written declaration in favor of a noncustodial parent that the custodial parent will not claim the child as a dependent.
c. Maintenance: Generally, maintenance payments are included in the gross income of the recipient spouse and they are deductible from the income of the payor spouse.
( 1) Statutes:
26 USCA § 215
(a) General rule. In the case of an individual, there shall be allowed as a deduction an amount equal to alimony or separate maintenance payments paid during such individual’s taxable year.
(b) Alimony or separate maintenance payments defined – For purposes of this section, the term “alimony or separate maintenance payment” means any alimony or maintenance payment (as defined in § 71(b)) which is includable in the income of the gross income of the recipient under § 71.
(c) Requirement of identification number – the Secretary may prescribe regulations under which (i) any individual receiving alimony or separate maintenance payments is required to furnish such individual’s taxpayer identification to the individual making such payments, and (ii) the individual making such payments is required to include such taxpayer identification number on such individual’s tax return for the taxable year in which such payments are made.
(d) Coordination with § 682 – No deduction shall be allowed under this section with respect to any payment, if by reason of § 682 (relating to the income of alimony trusts), the amount thereof is not includible in such individual’s gross income.
26 USCA § 71 – Alimony and separate maintenance payments
(a) General rule – Gross income includes amounts received as alimony or separate maintenance payments.
(b) Alimony or separate maintenance payments defined. For purposes of this section –
a. In general: the term “alimony or separate maintenance payment” means any payment in cash if – (i) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument, (ii) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under § 215, (iii) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and (iv) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse,
b. Divorce or separation instrument. The term “divorce or separation instrument” means – (i) a decree of divorce or separation maintenance or a written instrument incident to such a decree, (ii) a written separation agreement, or (iii) a decree (not described in subparagraph A) requiring a spouse to make payments for the support or maintenance of the other spouse.
(c) Payments to support children
a. In general – Subsection (i) shall not apply to that part of any payment which the terms of the divorce or separation instrument fix (in terms of an amount of money or a part of the payment) as a sum which is payable for the support of the children of the payor spouse.
b. Treatment of certain reductions related to contingencies involving child. For purposes of paragraph (1), if any amount specified in the instrument will be reduced – (i) on the happening of a contingency specified in the instrument relating to a child (such as attaining a specified age, marrying, dying, leaving school or similar contingency), or (ii) at a time which can clearly be associated with a contingency of a kind specified in subparagraph (a) – an amount equal to the amount of such reduction will be treated as an amount fixed as payable for the support of the children of the payor spouse.
c. Special rule where payment is less than amount specific in instrument. For purposes of this subsection, if any payment is less than the amount specified in the instrument, then so much of such payment as does not exceed the sum payable for support shall be considered a payment for such support.
(d) Spouse. For purposes of this section, the term “spouse” includes a former spouse.
(e) Exception for joint returns. This section and § 215 shall not apply if the spouses make a joint return with each other.
(f) Recomputation where excess front-loading of alimony payments (see Common Income Tax Considerations below)
(g) Cross references.
a. For deduction of alimony or separate maintenance payments, see § 215.
b. For taxable status of income of an estate or trust in the case of divorce, etc., see § 682.
d. Legal Fees: Normally, legal fees paid for a divorce are not deductible on income taxes. I.R.C. § 262. However, Section 212 allows for the deduction legal fees in three instances as miscellaneous itemized deductions on Schedule A of federal form 1040: (1) If the fees can be tied to collect; (2) If the fees can be tied to the management, conservation or maintenance of property held for the production of income; or (3) If they can be tied to the determination, collection, or refund or any tax.
B. Tax Impact of Division of Assets and Marital Property
1. Tax Consequences as a Factor
RSMo § 452.330: Disposition of property and debts, factors to be considered.
1. In a proceeding for dissolution of the marriage or legal separation, or in a proceeding for disposition of property following dissolution of the marriage by a court which lacked personal jurisdiction over the absent spouse or lacked jurisdiction to dispose of the property, the court shall set apart to each spouse such spouse’s nonmarital property and shall divide the marital property and marital debts in such proportions as the court deems just after considering all relevant factors including:
(1) The economic circumstances of each spouse at the time the division of property is to become effective, including the desirability of awarding the family home or the right to live therein for reasonable periods to the spouse having custody of the children;
(2) The contribution of each spouse to the acquisition of the marital property, including the contribution of a spouse as a homemaker;
(3) The value of the nonmarital property set apart to each spouse;
(4) The conduct of the parties during the marriage; and
(5) Custodial arrangements for minor children.
2. For purposes of sections 452.300 to 452.415 only, “marital property” means all property acquired by either spouse subsequent to the marriage except:
(1) Property acquired by gift, bequest, devise, or descent;
(2) Property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise or descent;
(3) Property acquired by a spouse after a decree of legal separation;
(4) Property excluded by valid written agreement of the parties; and
(5) The increase in value of property acquired prior to the marriage or pursuant to subdivisions (1) to (4) of this subsection, unless marital assets including labor, have contributed to such increases and then only to the extent of such contributions.
3. All property acquired by either spouse subsequent to the marriage and prior to a decree of legal separation or dissolution of marriage is presumed to be marital property regardless of whether title is held individually or by the spouses in some form of co-ownership such as joint tenancy, tenancy in common, tenancy by the entirety and community property. The presumption of marital property is overcome by a showing that the property was acquired by a method listed in subsection 2 of this section.
4. Property which would otherwise be nonmarital property shall not become marital property solely because it may have become commingled with marital property.
5. The court’s order as it affects distribution of marital property shall be a final order not subject to modification; provided, however , that orders intended to be qualified domestic relations orders affecting pension, profit sharing, and stock bonus plans pursuant to the U.S. Internal Revenue Code shall be modifiable only for the purpose of establishing or maintaining the order as a qualified domestic relations order or to revise or confirm its terms so as to effectuate the expressed intent.
6. A certified copy of any decree of court affecting title to real estate may be filed for record in the office of the recorder of deed of the county and state in which the real estate is situated by the clerk of the court in which the decree was made.
b. Relevant Case Law:
Barth v. Barth, 372 S.W.3d 496 (Mo. App. 2012): Tax consequences are a factor to consider in dividing martial assets in divorce proceedings; however, the trial court is not permitted to make deductions to the marital estate for estimated tax liabilities absent sufficient evidence to support its findings.
Elrod v. Elrod, 192 S.W.3d 738 (Mo. App. 2006): In dividing marital property, a potential tax consequence could attach to the sale of “rolling stock” assets awarded to husband. Although not precisely determinable until each asset was sold, asserts carried a potential tax burden that reduced their value in husband’s hands, and tax burden resulted from accelerated appreciation taken during marriage, which reduced tax liability of both husband and wife.
Brown v. Brown, 14 S.W.3d 704 (Mo. App. 2000): Tax consequences are a factor to consider in dividing marital assets, and the trial court is determined to know the tax law.
2. Retirement Benefits – Qualified Domestic Relations Orders
26 USCA § 408. Individual retirement accounts
§ 408(d)(6). Transfer of account incident to divorce.
The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument … is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.
b. Case Law:
Calhoun v. Calhoun, 156 S.W.3d 410 (Mo. App. 2005): Failure to award wife credit for tax consequences flowing from award to her of individual retirement accounts (IRA) in determining maintenance and property awards was not an abuse of discretion.
3. Common Income Tax Considerations
a. General Rule: Gross income includes amounts received as alimony or separate maintenance payments. 26 USCA § 71(a).
i. Statute on Frontloading Maintenance Payments
26 USCA § 71(f) – Recomputation where excess front-loading of alimony payments
(1) In general, if there are excess alimony payments –
a. the payor spouse shall include the amount of such excess payments in gross income for the payor spouse’s taxable year beginning in the third post-separation year, and
b. the payee spouse shall be allowed a deduction in computing adjusted gross income for the amount of such excess payments for the payee’s taxable year, beginning in the third post-separation year
(2) Excess alimony payments. For purposes of this subsection, the term “excess alimony payments” mean the sum of
a. the excess payments for the 1st post-separation year, and
b. the excess payments for the 2nd post-separation year
(3) Excess payments for 1st post-separation year. For purposes of this subsection, the amount of excess payments for the 1st post-separation year is the excess (if any) of –
a. the amount of the alimony or separate maintenance payments paid by the payor spouse during the 1st post-separation year, over
b. the sum of – (i) the average of – (I) the alimony or separate maintenance payments paid by the payor spouse during the 2nd post-separation year, reduced by the excess payments for the 2nd post-separation year, and (II) the alimony or separate maintenance payments paid by the payor spouse during the 3rd post-separation year, plus (ii) $15,000
(4) Excess payments for 2nd post-separation year. For purposes of this subsection, the amount of the excess payments for the 2nd post-separation year is the excess (if any) of –
a. the amount of the alimony or separate maintenance payments paid by the payor spouse during the 2nd post-separation year, over
b. the sum of – (i) the amount of the alimony or separate maintenance payments paid by the payor spouse during the 3rd post-separation year, plus (ii) $15,000.
a. Where payment ceases by reason of death or remarriage. Paragraph (1) shall not apply if – (i) either spouse dies before the close of the 3rd post-separation year, or the payee spouse remarries before the close of the 3rd post-separation year, and (ii) the alimony or separate maintenance payments cease by reason of such death or remarriage
b. Support payments. For purposes of this subsection, the term “alimony or separate maintenance payment” shall not include any payment received under a decree described in subsection (b)(2)(C).
c. Fluctuating payments not within control of payor spouse. For purposes of this subsection, the term “alimony or separate maintenance payment” shall not include any payment to the extent it is made pursuant to a continuing liability (over a period of not less than 3 years) to pay a fix portion or portions of the income from a business or from compensation for employment or self-employment.
(6) Post-separation years. For purposes of this subsection, the term “1st post-separation years” means the 1st calendar year in which the payor spouse paid to the payee spouse alimony or separate maintenance payments to which this section applies. The 2nd and 3rd post-separation years shall be 1st and 2nd succeeding calendar years, respectively.
4. Tax Planning Strategies
In a family law case, it is usually wise for a client to employ a tax expert (forensic accountant or a personal accountant at a minimum) to help advise a client as to the tax consequences as to the effects of a divorce and the decisions a client will have to make as to possible resolutions to a case. Tax experts can often give client’s tax advice that is valuable to the resolution of a case that a family law attorneys simply cannot give.
Some common tax planning strategies that might come into play are as follows:
a. Filing Status (Married or Single): A person is considered married for the entire tax year if they are married on December 31 of that year. If a divorce was granted before the last day of the year, then that person is considered single for that tax year. Thus, tax filing status can be an important strategic decision for many couples getting a divorce. Often, couples will hold finalizing a divorce after a settlement until the next year to take advantage of the marriage status. In contrast, changing to a single status is also a motivating factor for people to conclude their divorce before the end of the year.
b. Tax Exemptions: Claiming children as a tax exemption is a matter that is determined by the Internal Revenue Code. In short, federal tax law provides that the parent with primary physical custody or the parent who the children live with for more than half the year are entitled to claim the children as a tax exemption. Interpreting this definition between parents who have a joint custody agreement can be difficult.
c. Child Support or Alimony: Normally, child support is not considered taxable income to the recipient. It is also not considered tax deductible to the obligated parent. However, maintenance is considered taxable income to the recipient and is tax deductible to the obligated party. This is not true in every situation, including lump sum maintenance, which makes this distinction strategically important in settlement negotiations. While the division of property is not taxable to either party, there may be certain tax reasons to label certain payments as alimony as opposed to property division or child support. This must be weighed against the modifiable nature of alimony.
d. Retirement Accounts: Normally, withdrawing money from a 401(k) or an IRA is considered a taxable event that requires a party to pay income tax on the funds contributed as well as penalties. When accrued during marriage, retirement accounts are also considered marital property and are subject to equitable division in family court. The Internal Revenue Code recognizes that a Qualified Domestic Relations Order (“QDRO”) can divide funds in a 401(k) or similar retirement account. This allows the providers to roll funds into a retirement account for their spouse. While QDROs do not apply to Individual Retirement Accounts, a spouse can avoid a taxable event by rolling the divided funds into another qualified retirement account. Know that a spouse who converts any retirement funds to cash will be responsible for taxes and penalties for the account.
e. Tax Refunds: A tax refund coming to married parties is considered marital property subject to an equitable division in state court. Additionally, tax debt is also considered a marital debt. Parties who file jointly receive a refund check issued in both names. Judgments should account for how a tax refund or tax debt is to be addressed.
f. Maintenance Trusts: In divorces where high assets are involving, the use of a trust when structuring a support plan may be beneficial. A trust such as this can provide tax benefits by shifting income from a spouse in a higher tax bracket to a spouse in a lower tax bracket. It can also provide assurances that maintenance will be paid on time. I.R.C. § 682 of the Internal Revenue Code provides the requirements of Section 71 for maintenance paid through a trust in that it must be pursuant to a divorce or written separation agreement that is part of a divorce judgment. Some parties may consider a QTIP Trust (“Qualified Terminal Interest Property”). If child support is also paid out of a trust, it should be paid out of a separate trust from the one paying the maintenance obligation. Maytag v. C.I.R., 370 F.2d 914 (10th Cir. 1966).
g. Annuities: Some taxpayers may satisfy their maintenance obligations by purchasing an annuity for the former spouse or by transferring an existing annuity to him or her.
5. Property Tax Issues
26 USCA § 1041: Transfers of property between spouses or incident to divorce
(a) General rule. No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) –
(1) a spouse, or
(2) a former spouse, but only if the transfer is incident to the divorce.
(b) Transfer treated as gift; transferee has transferor’s basis. In the case of any transfer of property described in subsection (a) –
(1) for purposes of this subtitle, the property shall be treated as acquired by the transferee by gift, and
(2) the basis of the transferee in the property shall be the adjusted basis of the transferor
(c) Incident to divorce. For purposes of subsection (a)(2), transfer of property is incident to the divorce if such transfer –
(1) occurs within one year after the date on which the marriage ceases, or
(2) is related to the cessation of the marriage.
(d) Special rule where spouse is nonresident alien. Subsection (a) shall not apply if the spouse (or former spouse) of the individual making the transfer is a nonresident alien.
(e) Transfers in trust where liability exceeds basis. Subsection (a) shall not apply to the transfer of property in trust to the extent that –
(1) the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds
(2) the total of the adjusted basis of the property transferred.
Proper adjustment shall be made under subsection (b) in the basis of the transferee in such property to take into account gain recognized by reason of the preceding sentence.
b. Case Law:
Keller v. Keller, 877 S.W.2d 192 (Mo. App. 1994): Trial court was required under the IRC to use as ex-wife’s basis upon sale of the former marital residence the original tax basis husband and wife had in the home, rather than ex-wife’s basis at the time of dissolution. Note: the court referenced § 1041 in saying that property exchanges incident to dissolution are nontaxable events to the parties, and parties must carryover the original basis in property exchanged and use such basis in computing capital gain or loss in the event of a sale.
6. Practical Application – Examples
Example 1: In some situations where you have a client who will be paying child support and maintenance, it is to the advantage of the payor spouse from a tax perspective that they pay more in maintenance than child support because maintenance is deductible on their taxes. On the other hand, you have to balance this against the fact that if maintenance is modifiable and indefinite, that they do not get an automatic termination of the maintenance obligation, unlike child support that ends when a child is emancipated.
Example 2: Where there are multiple retirement accounts in a divorce that involve Traditional and Roth IRAs, the Roth IRA can be advantageous to over the Traditional IRA because it is post-tax.
Example 3: Where a client is going to owe a spouse money for property division, versus allowing a client to make a withdraw on a retirement account to satisfy their obligation, a QDRO or assignment should be utilized.