When a property is transferred because of a divorce, is the transfer of property taxable, and what tax issues should be considered?
This is a common question when an individual is going through a divorce and begins to look at and consider the settlement agreement and terms the parties are discussing. The article and information below has been prepared by a tax attorney to provide general information regarding common tax matters and issues related to a divorce, separation of property, and payments made after the divorce may have been finalized. Please remember to consult your divorce attorney and/or tax attorney to discuss the specific tax implications of your divorce proceedings and related agreements.
Perhaps the key Internal Revenue Code section regarding this matter is Section 1041. In general, IRC Section 1041 holds that transfers of property from one spouse to another spouse (or a former spouse) are not taxable when the transfer of property is incident and through a divorce. It is important to note that if through the divorce, the parties agree to sell the property to a third party, or the court orders the sale of the property to a third party, the transfer or sale would be taxed under the normal tax principles. This is so because the sale or transfer of the applicable property is not considered to be a sale or disposition subject to divorce. The non-taxable transfer of retirement accounts such as 401(k)s and similar profit-sharing plans require a specific court order known as a Qualified Domestic Relations Order, which is often referred to as a QDRO.
What about alimony? Is alimony taxable? Yes, alimony payments will be taxable to the spouse that receives the alimony payment and is deductible by the spouse (payor) that is paying the alimony. It is important for the parties to know that they can also opt-out of payments being considered alimony. The parties must specifically state in the divorce documents and instruments that the payment is not alimony and thus not taxable to the recipient and thus not deductible by the party making the payment.
What about child support payments? Are child support payments taxable? No, child support payments should not be taxable to the recipient, nor is the party making the child support payment allowed a tax deduction for making the payment.
For example, Jack and Jill are finalizing their divorce agreement and the agreement holds that Jack will pay Jill $500 per month in maintenance and $700 per month in child support. The $500 maintenance payment would be taxable income to Jill and a tax deduction to Jack. The $750 child support payment would not be taxable to any party, and Jack would not be allowed a deduction.
In addition to consulting with a divorce attorney or family law attorney, you may wish to consult with a tax attorney regarding the tax implications of your divorce decree and settlement documents.