As of January 1, 2019, maintenance and alimony are no longer tax deductible. This is because of the Tax Cuts and Jobs Act of 2017. Under the new scheme, maintenance awards are paid using net income rather than gross income and the spouse paying maintenance must pay taxes on the income earned and used to pay maintenance.
Generally, transfers of property incident to a divorce are free of taxes. When such transfers are made under a decree of divorce, the transfers are non-taxable events.
The Family Home
If the owner has used a residence as his or her principal residence for at least two of the past five years, then the first $250,000 of capital gain for a single person or $500,000 for most married couples who file joint income tax returns, is non-taxable. There is no reinvestment requirement for these tax-exempt gains, and the exclusion is not a one-time benefit. Therefore, the equity in your home is probably worth “more” than an equivalent amount of equity in stock that has preexisting gains and a higher “tax basis.” Although the gross value of both assets is the same, the tax basis is different and therefore the net value after taxes is lower for the asset with more tax associated with it.
Stocks and Mutual Funds
The taxes owing on stocks is reasonably easy to calculate. In general, the tax basis for a stock is the price at which you acquired the stock. The capital gains and losses are taxed at your ordinary income tax rate (for stock held less than a year), or 15-20 percent for stock held more than a year. This does not include Colorado state taxes at 4.63 percent or the net investment tax for certain, high-earning taxpayers. That means that the equity in the appreciated stock that you hold outside of retirement plans is generally worth at least 20 percent less in a divorce than equivalent assets in a money market account. Because courts often do not factor the potential tax liabilities when considering how to divide property at trial, knowing which assets are “better” because the assets have lower tax implications is critical.
One of the most dangerous assets in a divorce is rental real estate because it is considered a depreciable asset under the tax code. What this means is that such assets are entitled to depreciation allowances over time, thereby reducing the tax basis but lowering the owner’s tax burden. The value of a piece of rental real estate is typically much lower than what is listed as its gross value. When the property is sold, the tax code provides that all of the depreciation taken over the years is “recaptured.” On paper, a rental property may have a fair market value of $500,000 or so but the taxes associated with selling the property could be $100,000-$300,000 or more. If a mortgage is on the property, it is not uncommon for the property to have almost no value on sale after the taxes, commissions, and mortgages are all paid.
Because of this, the equity you have in your rental property, depending on how long you have held it. In a divorce, you do not want to be allocated an asset that has a value of $500,000 on paper but is actually worth nothing.
The more than people know your company and your brand, the more likely they are to purchase things from you. Because business valuators understand this, they put a value on brand awareness called “goodwill.” Even though all of that separately estimated “goodwill value” could equal zero if you left the company or passed away, it is measured as an “asset” and divided equitably between you and your spouse. In essence, your company’s popularity has value and the person receiving that value has to pay for it in a divorce.
Colorado courts usually give the business owner all of the goodwill and provide the spouse its value in other assets (or a note secured by the business interest). In general, the courts do not take into account the taxes payable on the sale of the business unless it is actually being sold. That may mean that one party is awarded the house with no taxes payable upon sale while the other receives a business, which has significant tax implications on sale.
Tax Filing Status
Generally speaking, a person’s tax filing status is determined as of the last day of the tax year. It can be determined as of other days during the tax year if you happen to have died before year’s end, but for purposes of people who are reading this article (no matter how bad your marriage might be) we’ll just assume you are in the category of people whose tax filing status is determined as of the last day of the tax year.
Head of Household
It is acceptable to file as head of household when the taxpayer is not married at the end of the year or when the filer files a separate return and the other spouse did not live in the same abode during the last six months of the tax year. Head of household tax filing status may be used only if the taxpayer paid more than half of the costs of keeping up his or her home during that tax year, the home was the principal residence of that taxpayer’s qualifying dependent for more than half of that tax year, and the taxpayer is a US citizen or legal resident for the duration of the entire year. Since 2005, an adult child must be classified as a dependent before the parent can claim head-of-household status. Only the taxpayer who claims the head-of-household status is entitled to claim the dependent care credits.
Certain tax benefits are only available to married couples that file jointly. For example, the earned income credit and child tax credit cannot be claimed for a married couple unless they file jointly.
Married Filing Separately
The important thing to remember about Married filing Separate tax returns is that they can be amended into married filing joint tax returns. The opposite, however, is not true. A joint return once filed can only be amended by another joint return.
Single status can only be utilized for unmarried persons and for persons who are divorced by year’s end.
In divorce, if your spouse gets the equity in the family home, and you wind up with “the same” amount of equity in the rental properties you own, while you each split stocks having a different tax basis, you may not be getting a fair deal at all. In fact, it is highly likely that you are getting far less than your spouse in real terms. Many assets are treated differently by the divorce courts in Colorado than they are in real after-tax terms. If you are thinking about divorce, you need to be aware of these differences, so that you don’t come out with an unfair settlement.
Furthermore, if you are getting a divorce, you need to take a serious look at which filing status benefits you the most. You need to look at the requirements for the various exemptions and credits, and you should be mindful of how each decision will affect your tax filing. There are many tax considerations to take into account in a divorce, and the above article just scratches the surface of the tax consequences of a divorce. A CPA and/or a tax attorney should be consulted for legal advice in complex divorce cases.
Suzanne Griffiths is the managing shareholder, CFO, and co-founder of Griffiths Law PC. She was recognized by the Best Lawyers in America© in 2019 for family law and was selected to Colorado Superlawyers from 2005-2019. She was also recognized in 5280 magazines for Top Lawyer in Family Law in Denver from 2016-2019.