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An introduction to tax consequences of divorce in California

When Californians face the prospect of a divorce, their attention is usually fixed on child custody, child support, alimony and the division of marital assets. One issue that may not receive attention until it’s too late is the tax implications of a divorce. This post will provide an introduction to some of the income tax consequences of divorce.

Alimony and child support are the two simplest issues. Child support is not deductible by the payor spouse and it is not taxable income to the receiving spouse. Alimony, on the other hand, is deductible by the payor spouse and taxed as income to the receiving spouse. To receive this tax treatment, alimony must be a cash payment that is not intended to be child support, and the payments must cease upon the recipient’s death. Some divorcing spouses who are required to pay child support attempt to disguise the payments as alimony. Such efforts are strictly forbidden and may result in charges of tax evasion.

More complex questions arise in the case of property division or the transfer of assets. Generally speaking, the transfer of assets from one divorcing spouse to another, so long as the transfer is incident to a divorce, does not result in the recognition of gain or loss. In order to qualify for such treatment, the transfer must be made pursuant to a divorce or separation instrument and must occur not more than six years after the divorces becomes official. A property transfer made under a property settlement agreement that is incorporated into a divorce decree is also not subject to the unified gift and estate transfer tax. This rule is usually important for high-asset couples who own property worth several millions of dollars. Income tax consequences may also affect the liquidation of assets that have risen in value during the marriage.

The complexity of tax issues in a high-asset marriage usually requires the professional assistance of an attorney or accountant or both. Anyone concerned about the income tax consequences of an impending divorce may wish to consult an divorce attorney for advice on how state and federal taxes may affect the financial aspects of the divorce.

Source: Journal of Accountancy, “Tax considerations when dividing property in a divorce,” Ray A. Knight, CPA, JD, and Lee G. Knight, Ph.D, April 1, 2013