Create New Estate Planning Documents for each spouse:
There are some odd statutes to be avoided with respect to the disposition of an estate plan between divorced spouses. Don't rely on the statutes.
Revoking Irrevocable Trusts:
- Life Insurance Trusts
- Tax consequences of unwinding an Irrevocable Life Insurance Trust.
- Gift tax
- Estate Tax
- Income Tax
- Unwinding a QPRT: Qualified Personal Residence Trust.
- Unwinding a Family Limited Partnership
- Unwinding a Stand Alone Generation Skip Trust
Understanding Complicated Assets: Many high net worth people have stock options, qualified and unqualified plans, pensions, annuities, oil leases FLPs, etc.
Spousal Maintenance v. Child Support: Child support payments and spousal maintenance payments are not treated the same under the tax code. Child support payments are never taxable income for the payee and are not a deduction for the payer. However, spousal maintenance payments are deductible from income by the payer and are included in the income of the payee. A divorce decree or settlement agreement should specifically allocate what portions of payments are attributable to child support and spousal maintenance.
Tax Deduction for Children: The tax code allows several deductions and credits for children supported by a taxpayer. After a divorce, the custody of a child may be split between both parents. However, the IRS will only allow one parent to claim the child on their tax return. Divorce decrees and settlement agreements will often state which parent will be allowed to claim the child on their tax return. The IRS is not bound by these agreements. For an agreement to be binding on the IRS, the parties must execute IRS Form 8332. Absent the execution of this form, the IRS will default to the parent who has custody the majority of the days in a year.
Not All Assets Are Created Equal: Different assets will often have different tax treatment under the tax code. Some assets, such as capital assets, are taxed at preferred rates. Other assets, such as retirement accounts, are taxed as ordinary income as they are withdrawn.
Division of Assets Incident to Divorce: The division of assets is generally not a taxable event. See I.R.C. § 1041. However, any built-in gains associated with the divided assets are preserved. Before agreeing to a property settlement agreement, it is important to consider the future tax burden of each asset.
Recapture of Depreciation: Assets that are depreciable, e.g. rental property or property used in a trade or business, inherently have higher built-in gains associated with the property. Each year property is depreciated, the adjusted basis of the assets is reduced proportionately, thereby increasing the eventual gain that will be realized when the property is sold.
Division of Retirement Accounts: There are two basic issues when dividing a retirement account. 1) Tax consequences of the initial division, and 2) tax consequences when assets are withdrawn from the accounts. To ensure that the proper tax consequences are achieved, a qualified domestic relations order or QDRO is necessary.
Allocated Gains/Losses Associated with a Partnership: Property with built-in gains/losses that were contributed to a partnership may have created special allocations within those partnerships. Division of partnership interests may have unintended consequences if special tax allocations are not taken into account.
Filing Status While Going Through a Divorce: Parties who are in the process of divorce should never be required to file a joint income tax return. Joint returns make both parties jointly and severally liable for the tax consequences of the return. Both parties are also required to attest to the accuracy of the return under penalties of perjury.
Tax Trouble When Parties Divorce: Property settlements and divorce decrees do not only divide assets and other property. These agreements apply equally to debts of the marriage. How can parties deal with unresolved tax debts?
Unfiled Returns: If returns have not been filed by either spouse, the potential liability associated with these tax years must be dealt with. Joint tax returns should be avoided. Separate tax returns create separate liability.
Innocent Spouse Relief: If tax debts are attributable to one spouse, the innocent spouse, or the spouse who did not give rise to the liability, may be eligible to be released from joint and severable liability for the tax debt.
Hidden Assets: Assets hidden from the IRS or other tax authorities are a ticking time bomb and should be dealt with in a divorce proceeding. Such assets can give rise to both civil and criminal liability.
Whistleblower Actions: Taxpayers who are aware of tax fraud being committed by someone else can notify the IRS and may receive a reward from the IRS for making the tip. Ex-spouses are the most common whistleblowers.