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Colorado Divorce and Income Tax Ramifications

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A Colorado divorce case can have many facets to it, whether financial or child related. The financial aspects of a divorce case can include property division, alimony (properly termed “maintenance”), and child support. With those financial aspects come various nuances and intricacies of which your expercienced Colorado family law attorney should be aware. One category of nuances tied into the financial aspects of a divorce case relates to taxes.

Most Denver area divorce attorneys have a basic understanding or knowledge of tax implications tied into a divorce case. Because the Internal Revenue Code is a volumious and shifting literary compilation, most family law attorneys are hesitant to give concrete tax “advice” to their clients. That does not mean that we cannot import general tax information or knowledge to our clients with the caveat of, “you should follow up with an accountant to be certain.” In essence, family law attorneys are not tax experts. Despite the lack of expertise as relates to taxes, set forth below are some of the basic topics in which tax issues can arise in a Colorado divorce case and basic information related to such.

MAINTENANCE:

“Maintenance” is the proper term for what people might often call alimony in Colorado. Alimony is essentially spousal support. Colorado statute and case law indicate that depending upon financial circumstances, one spouse may have a duty to financially support the other, for a certain period of time, during and after a divorce case. The issue of taxes arises in an alimoy situation in that the Internal Revenue Code allows the party paying alimony to deduct the payments he or she makes from his or her income on the tax return. This can include temporary maintenance paid while a divorce case is pending, maintenance paid after the divorce is done, or sometimes “unallocated” support that is not necessarily defined, so long as that “unallocated” support is not classified as child support. When one is in an alimony paying situation, it becomes important to speak with a learned accountant to find out specifically your rights, obligations, and what documentation you may need, from an IRS stand point, to be able to claim the deduction. An accountant can also strategize with you in terms of making sure you handle your tax affairs in proper fashion as relates to alimony. The tax code is tricky and subtle deviations in how you pay or what you pay can have an effect. For example, the IRS may allow you to deduct the $2000 in alimony you pay on a monthly or “periodic” basis, but might disallow the deduction if you pre-pay for the year in a lump sum. The primary point is that as an alimony payor, you need to be informed as to the tax benefits and consequences tied into your court orders.

Just as the alimony payor is entitled to claim a deduction for spousal support paid, the payee incurs a tax liability or obligation on the alimony that he or she receives. Tax forms are set up such that the payor will indicate what he or she has paid and will provide the recipient’s social security number. Thus, the IRS will be able to correlate or cross reference social security numbers. As such the recipient of alimony should also be aware that he or she will have a tax consequence and should plan accordingly. Again, conferring with an accountant would be worthwhile. As indicated above for the payor, nuances as to what is paid, categorization of payments, lump sum payments, etc. can also have an effect upon the payee.

CHILD SUPPORT:

A common tax issue that arises in any divorce case with children relates to the issue of child support and the right to claim the income tax dependency exemption for the children. The common misconception held by most people, prior to speaking with a divorce lawyer, is that custody of a child determines who gets to claim that child on taxes. This is just not true. Colorado Revised Statutes, C.R.S. 14-10-115, sets forth that the right to claim the income tax dependency exemption for a child shall be allocated by the court, absent an agreement of the parties, proportionately to the parties’ contributions to the cost of raising the child, meaning their incomes. Internal Revenue Code defers to state law on this issue and allows the state to issue orders as to how the exemptions will be divided. This idea is contrary to lay schools of thought and contradicts the advice accountants might give to people. Using the proportion of income analysis, if there are 3 children in a family and the mother makes $100,000 per year and the father makes $50,000 per year, mother should be able to claim the dependency exemption for 2 of the 3 children each year. Both parties should keep in mind that C.R.S. 14-10-115 also indicates that a party loses his or her right to claim a dependency exemption for a specific tax year if he or she has not paid all court ordered child support for that tax year. Likewise, statute indicates that to claim the exemption one must also derive a “benefit,” which could be construed as a wide array of things. Statute does not give a monetary definition of the term “benefit.” One must keep in mind that other tax designations or deductions, such as head of household or the right to claim day care paid for a child are not the same thing as the dependency exemption. Regarding those issues, whether from a tax planning or return prepartion standpoint, speaking with an accountant is also advised. Unlike the dependency exemption, other aspects of tax code related to children and support do depend upon which parent has primary residential custody.

PROPERTY:

The division or disposition of property in a divorce case can also bring tax ramifications. The specific tax issues which may arise will generally relate to the classification of property. For example, when dividing a retirement plan, such as a 401K, the actual division is not as simple as pulling one-half out of the account and giving the proceeds to the other party. Simply withdrawing funds will generally come with a 20% to 30% combined tax and penalty. In a general sense, tranfers of property incident to a divorce are not considered taxable events. However, proper procedures must be followed to prevent a tax liability. With the 401K analysis, the parties must divide the plan through what is called a “Qualified Domestic Relations Order.” This order will allow for the tranfer without a tax liability being incurred by the spouse who holds the plan. With an IRA, so long as funds are rolled over into another IRA set up in the other spouse’s name, or a similar qualifying account, there should be no tax consequence. Of course, if the receiving spouse decides to cash out the funds received, he or she will bear a tax liability which will have no affect on the first party.

Another area of property division in which tax issues can arise relates to real property. Should the parties to a divorce agree, or be ordered by the court, to sell their marital home, or a second home, there could be capital gains taxes associated with the sale. Likewise, with the sale of a home, or even if one of the parties is keeping the home, it is common for the parties to allocate certain tax deductions, such as who will get to claim the mortgage interest deduction for the times during the year prior to resolution of the divorce. Property tax paid may also be deductible. The court can allo
cate the rights of parties related to the claiming of these deductions, unless IRS Code makes a clear distinction as to which party would get to claim what deduction. With homes, whether related to deductions or any sort of gains tax, it is important to consult with an account before making certain decisions.

Though most family law attorneys are not CPA’s or tax attorneys, we do strive to have a general understanding of how a divorce will impact, or benefit, our clients from a tax perspective. Our experienced divorce lawyers approach each case from an holistic standpoint and recognize that financial matters extraneous to a case, such as taxes, can also have a bearing on how things should be dealt with. A proper undertsanding of the tax ramifications of your divorce can save both time and money down the road.

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