After a divorce is final, assets change hands. It is important to understand what part of the settlement is taxable and to what party. In the case of alimony, the amount is taxable to the person who receives the support. In return, the person paying the money receives a tax deduction. Certain requirements must be met for the money to be considered alimony. To begin, the exchange must be in cash or an equivalent, payment must be made under a court order, the parties must live separately, there are no requirements of payment after the receiving party dies and each party files tax returns separately.
When a divorcing couple has children, child support is often part of the settlement. This money is not deductible.
Besides alimony, divorce usually contains a property settlement as well. Many times, it is not recommended for a couple to equally divide marital assets. It is better to give one party a lump sum settlement for equity interest. For instance, when the couple has a home with a mortgage, it is common for one party to keep the house and pay the other spouse the equity as a property settlement. No taxable gain or loss is recognized.
Divorce lawyers will help couples understand what part of the settlement is taxable. The IRS has specific rules in place to prevent property settlements from qualifying for tax benefits. For instance, if a divorce decree orders the husband to pay his wife a large amount of alimony for one year with a lower amount to follow, the IRS uses the “recapture rule.” This requires the paying party to “recapture” some of the money as taxable income.
As if a divorce is not complicated enough, it is challenging to understand what part of a settlement is taxable. A divorce lawyer may be able to answer common tax questions.