Negotiating The Terms Of The Divorce

• Be sure your divorce agreement addresses the following tax issues: (1) alimony, (2) deductions for dependents, (3) property settlements, (4) child support, (5) funds in pension plans, and (6) division of taxable income if you reside in a community property state.
  
  
• Consider the use of a professional divorce mediator to help you negotiate the terms of separation or divorce.  Engage a divorce lawyer to review the final settlement.  Many divorce lawyers are not well versed in tax matters, consequently be sure to meet with your CPA before your divorce is finalized.

When Children Are Involved

• If you are divorced or separated, claim a $ 3,500 dependency exemption for 2008 for your child for whom you were the custodian the greater part of the year.  You must meet one of the following support requirements: (1) you provided over one-half of your child's support, or (2) your ex-spouse provided over one-half the support, or (3) both of you provided over half your child's support.
  
  
• If you are the noncustodial parent, deduct the
  $ 3,500exemption for 2001 if your former spouse allows you to claim the child by providing you IRS form 8332.
  
  
• If your divorce decree allows you, as the noncustodial spouse, to claim a dependency deduction for all years until the child ceases to qualify as a dependent, have your ex-spouse sign form 8332 with the following wording: For all future years.  Otherwise, you will have to ask your ex-spouse to sign form 8332 each year you wish to claim the child as your dependent.
  
  
• If both you and your ex-spouse are in the same tax bracket and you have two children, it generally makes sense to allow each of you to claim an exemption for one child.
  
  
• Claim medical expenses you pay for your child if the child can be claimed as a dependent by either you or your ex-spouse.
  
  
• If you have custody of a child under age 17 for a period during the year that is longer than the custody period of your ex-spouse, claim the Child Care Credit.
  
  
• Consider purchasing additional life insurance if you retain custody of children.
  
  
• Many state divorce courts assume that a financially well-off parent has a legal duty to send children to college even if the child is considered an adult at age 18 under state law.  If your child has a Uniform Gift or Uniform Transfer to Minors Account (UGMA or UTMA) where full distribution is not required until age 21, to minimize your responsibility to pay for college costs, the account should accumulate income until your child starts college.  Income and principal can then be paid out of the account semester by semester, in a series of unconditional checks.  Your child should deposit the check in an account and use the funds as needed for schooling.

Alimony

• Alimony is deductible by the ex-spouse who pays it and taxable to the ex-spouse who receives it. If the alimony payments that you make decrease by more than $15,000 during the second or third year of your divorce or separation, the excess alimony  you paid in the previous years may have to be included in your current year's income.
  
  This is applicable for divorces or separations occurring after December 31, 1986.  Exceptions to the excess alimony rule are granted in the case of death, remarriage, and fluctuating business income.
           
• Your divorce or separation decree should be drafted so that alimony payments are spread more evenly over the first three years of your divorce.  IRC 71(f)

Property Settlements

When structuring a property settlement, take into consideration both the fair market value and the tax cost of the property being transferred.  For example, if one spouse receives cash of $10,000 and the other receives stock valued at $10,000 with a tax cost of $1,000, the spouse receiving stock could end up with considerably less if he or she later sold the stock.  The federal tax on the sale of $10,000 of stock held at least a year with a tax cost of $1,000 could be as high as $1,800, leaving that spouse with only $8,200 after taxes.

Don't be duped into receiving a burned out tax shelter as a major portion of your property settlement.  Burned out tax shelters generate taxable income but don't distribute even enough cash to pay the tax.  They are frequently over-valued.  In many instances the taxable proceeds from the sale of the partnership property is used to pay off partnership debts.  Consequently, you get unwanted taxable income and little or no cash.  The only winner in this situation is your ex-spouse who got the tax benefits while you were married but left you holding the bag.

If you have Series EE or I bonds registered in your name avoid transferring the bonds to your spouse.  Accrued interest up to the date of the transfer will be taxable to you.

If for some reason you forget to include some property in your property settlement or you restructure the settlement after the divorce is final, you are allowed to sell the property in question to your ex-spouse without triggering income taxes.  The sale must be completed within one year of your divorce.  IRC 1041

Obtain a qualified domestic relations order (QDRO) from the appropriate state court that entitles you to all or a portion of your divorced spouse's nongovernmental pension benefits.  A distribution from your spouse's pension plan pursuant to a QDRO qualifies for a rollover into your IRA.  The rollover must be accomplished within 60 days of the payout.  IRC 414(p)(1)

If your spouse has a governmental pension seek to obtain your share of the account by requesting a property settlement equal to the present value of your share of the future benefits.  If the value of the retirement account is uncertain, or vesting has not occurred, or there are inadequate liquid assets to consummate a property settlement, then you should be guaranteed some percentage split when vesting occurs or when benefits commence.  In this event, you will probably have to return to court to enforce the payout.

Other Planning Strategies

In agreeing upon the amount of alimony and child support to be paid and the right to dependency exemptions, both your tax bracket and your ex-spouse's should be considered in order to minimize the overall tax burden.  Alimony is deductible by the payer and taxable to the recipient.  Child support is neither deductible nor taxable.  If the payer is in a high tax bracket and the recipient is in a low tax bracket, consideration should be given to increasing alimony payments and decreasing child support.  In addition, the child dependency deductions may be better utilized by the spouse in the higher bracket.  However, see Tax Planning: Deductions for Personal Exemptions.

Ask the IRS to relieve you of liability for amounts owed on a joint tax return where your spouse understated the taxable income, and the income was attributable to your spouse or the deductions were claimed by your spouse without your knowledge.  IRC 6015

If you are planning to sell your home, consider selling your home while you are eligible to file a joint tax return. Provided that you and your spouse meet the ownership and use tests, you will be eligible to exclude up to $500,000 of gain. If you are divorced or you are not eligible to file a joint tax return, the maximum that you will be able to exclude is $250,000.   IRC 121(b)(2)

Contribute up to $2,000 of alimony you receive to your IRA established by your ex-spouse.  IRC 219(f)(1)

Rewrite your will when your divorce is final.

Rewrite your revocable living trust and modify provisions that relate to your ex- spouse.

Revoke any power of attorney that involves your ex-spouse.

Have your parents or other family members consider modifications to their estate plans that involve your ex-spouse.

Upon your legal separation or divorce, consider changing the beneficiary designations on all your IRA's, pension plans, annuities, insurance policies, and other documents requiring a beneficiary designation.

Change jointly owned property with rights of survivorship to tenants-in-common.

If your divorced or separated spouse works for a company with 20 or more employees which has employer-provided health insurance, you are also entitled to the coverage for 36 months following your divorce or legal separation.  However, you may have to pay the monthly premiums.  If you have children and you are a custodial parent who doesn't work, your ex-spouse can generally obtain dependent coverage under his or her employer's plan.

Notify insurance companies of the change in your marital status.

Consider purchasing or increasing disability insurance if, as a result of the divorce, you commence employment, or the level of your employment income increases.

Be sure your attorney invoices you separately for any income tax advice relating to the divorce as legal fees for divorce generally are not otherwise deductible.