Tax issues lurk in many aspects of a divorce. Whether you are advising your client, negotiating with opposing counsel, structuring an agreement, or presenting your case to the judge, you must have a clear understanding of the tax consequences of the decisions made. Frumkes on Divorce Taxation provides plain-English explanations of complicated tax rules and regulations, and practical, step-by-step guidance for protecting your client’s best interests. For example:
Title controls liability for capital gain tax on sale of principal residence
The parties in whose name the title is held are liable for the capital gain tax, notwithstanding that the marital settlement agreement or the final judgment awards each party a different division of the proceeds. Thus, if the parties are to share the proceeds from the sale of the principal residence, and it is the parties’ intent that each pay capital gain taxes, if any, out of his or her share, then you must arrange for title to be in both names.
To ensure proper waiver of dependent child exemption, execute multiple IRS forms in advance
A non-custodial parent may claim the exemption for a dependent child only if the custodial parent formally waives the right to take the exemption. The non-custodial parent is required to attach to his or her income tax return for the year of the exemption a written declaration from the custodial parent, stating that he or she will not claim the exemption. This declaration is made on IRS Form 8332. The best practice is to obtain from the custodial parent, in advance, a signed Form 8332 for each child and each year that the non-custodial parent is to have the exemption. Do not leave this to the spouses to accomplish on their own. Instead, bring a supply of these forms to the mediation or settlement conference. If the case is tried, the final judgment should require the custodial parent to sign the required forms for each child, for each year of transfer of the exemption. Send the completed forms to opposing counsel, with instructions to have his or her client sign and return the executed forms.
Attorney’s fees related to tax advice are deductible, but should be separately allocated
A spouse may always deduct attorneys’ fees related to tax advice, under I.R.C. §212(3). The question is: What proof must the taxpayer provide in order to establish a basis for deductibility? Help your client avoid any issues related to this deduction by providing him or her with an allocated fee statement, which distinguishes between fees for tax advice and fees for other, non-tax matters. Keep in mind that there are many topics on which you can and should give tax-related advice, including, but not limited to:
- Unallocated alimony and child support
- The distribution of property, including qualified retirement plans and IRAs
- The sale of a principal residence
- The deductibility of interest payments on the mortgage encumbering the marital residence
- The transfer or award of stock options
- The execution or refusal to sign a joint tax return.
Avoid this common QDRO mistake: Overlooking loan balances
To protect your client from a post-divorce loan surprise, determine whether there are any existing loans against the defined contribution plan you are dividing. If not, include language in the Settlement Agreement asserting that there are no loans on the account and prohibiting the employee from taking any loans (or other withdrawals) until after the completion of the QDRO and division of the account. If there is an existing loan, find out what the loan was used for and come to an agreement on how the spouses will share the loan balance. In addition, it is good practice, in every case (even if loans are not an issue), to list the most current account balance available at the time of the Agreement, so that everyone has a baseline to determine the parties’ understanding of the account’s value (e.g., “Husband’s account in the ABC Company 401(k) Plan, which had a balance of $23,415.66 as of April 1, 2010, shall be divided as follows…”).
Update 10/20/2014: This post is excerpted from Frumkes on Divorce Taxation, by Melvyn B. Frumkes. We are saddened to report that Mr. Frumkes passed away in 2014. During his long and successful career, Mr. Frumkes practiced Marital and Family Law, with a special emphasis on complex asset and custody cases. Mr. Frumkes graduated, with honors, from the University of Florida, College of Law. He was Board Certified in Marital and Family Law by The Florida Bar, and was a Diplomate of the American College of Family Trial Lawyers, and a Fellow of the International Academy of Matrimonial Lawyers.