Alimony payments can be deducted by the payor and included in income by the recipient.
In order for this to work, the alimony must qualify as alimony.
The payments must be in cash, checks or money orders. If payments are to a third party (stated to be such in the divorce decree), the payments can be considered alimony if they otherwise qualify for alimony.
Payments must be required by the decree or separation agreement.
The decree cannot designate the alimony payments as “not alimony”.
Spouses can not be members of the same household (much as they may want to be).
Alimony payments cannot be treated as child support.
Alimony payor is not liable to make payments after the recipient’s death.
Payor and recipient cannot file a joint tax return.
Okay, say the decree is signed, the ink is dry and the next step is to actually divide the property. Don’t dilly dally.
According to the Internal Revenue Code, you don’t recognize a gain or loss on a transfer between spouses or to a former spouse incident to divorce. But you need to know the definition of “incident to divorce”.
A property transfer is “incident to divorce” if it….
1. Occurs within one year after the divorce or
2. It is made pursuant to a divorce or separation agreement and occurs within six years after the date the marriage ends.
Thus, get the property transfers into the decree and get them done within less than six years.
Tax effecting inventory items means to put them on the inventory at their after-tax values. Some people want to do this. But it is a bit tricky and never, in my opinion, is it accurate.
Example: The balance in a bank account is not subject to income tax upon withdrawal. But the contents of a traditional IRA or 401(k) account will be subject to income tax upon withdrawal. In this example, to tax effect the retirement account is to attempt to compare apples to apples.
However, the tricky part comes in with the calculation of the future taxes on the retirement account.
Shall we assume the retirement account is drained and taxed at the time of divorce? I think not, since that is usually unlikely. Shall we assume the retirement account is drained and taxed when one spouse retires? Which spouse? And when will that be…. for certain? At what tax rate shall we tax the retirement account withdrawals? What will the tax rates be at that point in the future? What deductions and credits will be used by the spouse (which spouse?) at that future point?
If we are all in an agreeable mood, we could agree on some assumptions. But those assumptions could be wildly inaccurate when the future arrives.
A traditional IRA is a personal retirement savings vehicle. Earnings in a traditional IRA are tax deferred. Contributions to a traditional IRA are either tax deductible or not tax deductible.
You pay income tax on the earnings when you begin to withdraw money from the traditional IRA. You pay income tax when you also withdraw money that represents the contributions that were deducted on your tax return when you initially contributed them to your traditional IRA.
A Roth IRA is also a personal retirement savings vehicle. Earnings in a Roth IRA are also tax deferred. In fact, if you meet certain conditions, the earnings are tax free even when you withdraw them. Contributions to Roth IRAs are not deductible.
A traditional IRA and a Roth IRA can be divided in divorce by taking a certified copy of the divorce decree to the custodian of the account (for example, Fidelity or Edward Jones or a bank).
There are basically two types of retirement plans: Defined Benefit Plans (DBP) and Defined Contribution Plans (DCP).
Defined contribution plans are retirement accounts such as 401(k), 403(b) and IRAs. There are employer-sponsored DCPs and personal retirement plans.
Employer-sponsored defined contribution plans include such plans as 401(k), 403(b), 457 plans, money purchase plans, thrift plans, tax-sheltered annuities, profit-sharing plans, employee stock ownership plans (ESOP), deferred compensation plans, SEP-IRA, Simple IRA and SAR-IRA.
Employer-sponsored defined benefit plans are pensions. Government-sponsored defined benefit plans are also pensions.
Personal retirement plans are annuities, traditional IRAs, rollover IRAs (IRRA) and Roth IRAs.
Some people categorize Social Security as a retirement plan, but given the current state of the Social Security system, that is debatable.
Dividing stuff can be emotional. Fortunately couples no longer have to fight over the photographs. Old slides can be converted to CDs. Photos can be scanned into computers at home and then burned on to CDs. And, for an increasing number of couples, all photos are on the computer, so scanning is not even required.
Pots and Pans. This is jargon for the little stuff. In my experience, the attorneys do not want to get involved in dividing the pots and pans. They would prefer the clients quietly agree together on how to divide the small stuff and simply tell their attorneys it is done. Some people may think attorneys are just interested in racking up billable hours, but I have never met an attorney who wanted to put in billable hours on dividing the stuff.
Furniture. This can be a sticky area when one spouse has moved out or plans to move out and buy all new furniture. First off, the spouse who is staying in the marital home may wish to get rid of some of the old furniture and wants the departing spouse to take some of it away. While the departing spouse wants to buy all new furniture and does not want to be bothered with hauling away old furniture. The sticky part comes when the non-moving spouse resents the departing spouse’s new furniture acquisitions. Adding insult to injury is when the departing spouse wants to include the replacement cost of the old furniture in his/her spouse’s column of the inventory or property division. Doing this results in more assets in his/her spouse’s column and thus, opportunity for more cash or other asset to be dropped into the departing spouse’s column. In collaborative cases, this situation is talked through and, in my experience, a mutually agreeable solution is always reached.
Collections. Some collections are emotionally valued but monetarily worthless. I feel this issue should be dealt with in a tactful manner. Let’s not insult anyone’s taste. However, if one spouse insists on assessing a high value to a collection of – for example – baseball cards, then it would be prudent to get a real appraisal of that collection. Now you are talking about spending money. Appraisals for personal property can be costly. One way to get around this is to check values on websites such as eBay. Be sure to print a copy of the eBay page to support the estimated value.
When creating an inventory or net worth statement for a divorce, some couples prefer to factor in selling costs for the house. Selling costs are deducted from the estimated value of the house. Usually, the person who wants to deduct selling costs is the person who is intending to keep the house. The reduction in house value from the deduction of selling costs means that person has less on his/her column, leaving room for more assets or money to be placed in their column.
The discussion over whether selling costs should be deducted can be a lively one. Couples talk about the likelihood of actually selling the house soon. After all, where do you draw the line on timing? If he/she intends to sell the house within 6 months, then they get to deduct the selling costs now? What if he/she has a change of heart and decides not to sell the house after all? What if he/she plans to sell the house in 4 years after Johnny has gone off to college?
Then there is the discussion of how much are selling costs? Are they only the real estate agent’s commission? Are they all the costs to sell (whatever those are in your geographical area). Do they include fixing up the house, such as repairs and painting? Then there is the differing opinion about whether painting the living room will produce a higher selling price anyway.
I don’t have an answer here. Just issues to consider. Every couple deals with this in their own unique manner.