In case divorce isn’t already stressful enough, you also have to think about how it will affect your taxes and filing status. This aspect of divorce is often overlooked until one party or the other gets hit with an unexpected tax bill during the next tax season. The way in which you split up assets can affect your taxes, so it’s important to handle the division of assets, such as property transfers, properly to avoid unwanted tax consequences for both parties.
As you navigate your Bay St. Louis divorce, make sure you have a strong and reliable divorce attorney by your side. Call Holcomb Johnson at 228-432-6652 to set up a time to talk to our team now.
Property Transfers Incident to Divorce
Property transfers are incredibly common during divorce, and because of this, divorce is treated differently than other situations in which property transfers happen. In general, the IRS allows tax-free transfers of property when those transfers are incident to divorce. “Incident to divorce” means that the transfer happens either within one year after the end of the marriage or is outside that time frame but related to the end of the marriage. For example, if property is transferred more than one year after the divorce but the transfer is in line with what is stated in the divorce decree, the transfer would be considered incident to divorce.
The best way to limit the tax consequences of a property transfer is to ensure that every transfer is incident to divorce. This means that you can’t engage in under-the-table deals or take on the transfer of property on your own. By outlining everything in your divorce agreement, you ensure that there is clear documentation of how your property is to be divided.
Deferred Tax Consequences
This doesn’t mean that the recipient of the property will never face tax consequences; it simply means that the tax consequences are deferred. In most cases, these tax consequences occur when they sell or give away the property. Consider a common scenario—one party keeps the marital home while the other is bought out of their share.
Party A keeps the home and lives in it for several years. A few years later, they remarry and decide to sell the home to purchase a larger one. At that point, they may have to pay capital gains taxes based on the difference between the value of the home when it was transferred and the value of the home at the time of the sale. These consequences would fall squarely on the shoulders of the spouse who kept the property, not the one who gave it up.
Ensuring That All Transfers Are Protected
To protect everyone involved from unintended tax consequences, it’s important for both parties to work with divorce attorneys throughout their split. In addition, parties who are likely to receive substantial assets may want to consult a tax professional or financial advisor to ensure that they understand the long-term consequences of their divorce agreement.
It’s especially important that both parties understand how different assets are handled during divorce. Consider retirement accounts—these are complex assets that can trigger different taxes and penalties if not handled appropriately.
For example, if Spouse A transfers a retirement account to Spouse B, it’s likely that Spouse B will either have to roll the funds into their own retirement account or create a new retirement account. Failure to do so within an appropriate time frame may trigger automatic taxation of what was withdrawn and an additional 10% penalty. Utilizing QDROs to transfer property correctly can cut down on these issues and protect both parties.
Future Tax Consequences
Don’t forget to discuss other tax issues as part of your divorce agreement. If you have children, who will claim them each year? If both parties share custody, what type of schedule will determine who claims them and when? This can also be important for the Earned Income Tax Credit since the number of children you claim on your taxes affects how much you receive for the EITC.
Prepare for Your Divorce with the Team at Holcomb Johnson
When you choose Holcomb Johnson for your divorce needs, you can feel confident that your best interests are our top priority. Set up a time to talk to our team of Gulfport divorce attorneys now—just reach out online or call us at 228-432-6652.