After divorce, assets may not be subject to income tax
Published: Monday, May 09, 2011, 7:06 AM Updated: Monday, May 09, 2011, 7:10 AM
Q. I will be getting a settlement from a divorce, and I would like to know what I can do to minimize taxes. Can you advise what’s the best way to get the most benefit from this money? I have three children and I believe a 529 plan might be an option.
– RA
A. Slow down. A 529 plan can be great for college savings, but before you consider investment options, it’s important to understand what’s taxable and what’s not in a divorce settlement.
Property transferred between spouses incident to a divorce settlement is not typically subject to income taxation, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial Advisors in Berkeley Heights.
Maye said for federal tax purposes, any transfer of property between spouses as a result of a divorce proceeding that happens within six years after the date of the divorce is presumed to be related to the divorce.
"If your divorce settlement is solely the transfer of assets between spouses, there likely would be zero income tax implications," he said. "An exception to this would be if a spouse under the divorce was given a portion of the spouse’s 401(k)."
If the receiving spouse fails to roll the 401(k) proceeds into an IRA, the proceeds would become taxable in the year it’s received as a distribution, Maye said.
"Spouses receiving settlements from deferred retirement accounts should be sure and roll them directly into an IRA to avoid immediate taxation," he said. "Failure to do so may also result in the 10 percent early withdrawal penalty for those under age 59½."
Maye said income taxation only comes into play in a divorce settlement when a marital asset is sold to a third party. For example, if a marital asset was sold to a third party and the spouses split the proceeds, they would also split the gain for tax purposes.
The tax rules before and after divorce are generally the same, said Jerry Lynch, a certified financial planner with JFL Consulting in Fairfield.
He said if you own a mutual fund or a stock, the original tax basis (cost) is what will be used in calculating gains for taxes. A stock bought at $10 that’s worth $20 after the divorce, if sold, for example, would yield a taxable gain of $10 per share.
The best advice?
"Take a step back and speak to someone familiar with taxes and your situation as your entire tax structure has changed," he said. "You are no longer filing as ‘married’ so all the tax brackets are different. Your income is probably less. Take some time to understand your new situation and then it will be much easier to make better decisions."
If you have questions about this posting or are interested in Divorce, Immigration, or Estate Law in RI or MA contact Massachusetts and Rhode Island Divorce Lawyer Rui P. Alves at 401-942-3100 or CONTACT him via email.
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