The day finally came when the Judge signed your divorce documents and declared your marriage officially dissolved. You walked out of the courtroom excited to move on with the rest of your life. If you do not act quickly, you may find that the amount of property you thought you would receive has been significantly reduced due to the tax implications of the transfers.
Pursuant to Section 1041 of the Internal Revenue Code, any property transfers between spouses pursuant to a divorce decree are tax-free if done within one year of the entry of the judgment. If you wait more than one year, you may still be able to get under the tax-free clause if you prove that the transfer was related to the cessation of the marriage. If you wait more than six years, there is a presumption that the transfer is not related to the marriage. This presumption can be rebutted with evidence that the transfer is related. The IRS has found the following exceptions to the six-year rule:
1) You can prove that the delay in transfer was a result of a dispute as to the value of the property, and the transfer occurred shortly after the dispute was resolved.
2) Annuities – Any transfers after six years is considered not related to the marriage unless you show that there was a compelling reason. In one case, the IRS found that a spouse showed compelling reason to wait more than six years when it was necessary for him to wait before transferring so that he could meet the value required pursuant to the parties’ Judgment for Dissolution of Marriage.
3) Transfer of business – In one case, the IRS found that there was a compelling reason to extend the transfer period to more than six years after the divorce when a dispute arose relating to the transfer of the business.
4) Maintaining investor confidence – the IRS has found that delaying the transfer of property such as business stocks in order to maintain investor confidence and thus maintain the value of the stock were sufficient reasons to delay marital property transfers.
5) Post-decree modification. The IRS has found that a post-decree order, or multiple post-decree orders, regarding a property transfer, even if not related to the original divorce decree, is considered a property related to the cessation of a marriage and thus a non-taxable event.
Although you may not think about the tax implications of transfers when you are getting a divorce, failure to act timely can result in steep tax implications. It is important to transfer all marital property within the one year to avoid any problems. Even though the IRS would allow transfers after one year, the IRS requires more documentation and explanation, and after six years, in only limited situations.