One of the most overlooked areas in a divorce decree is the tax implications of the agreement. Family Law Attorneys are not ethically able to give tax advice in Illinois, which is why clients are often encouraged to speak to their accountant regarding tax implications of a divorce decree. However, there are general, important tax considerations in a divorce decree and how they can impact your agreement. These repercussions need to be considered during the negotiations stage. Clients can severely undermine the use of an accountant in the early stages of divorce negotiations. This blog is intended to outline some of the more important areas to pay attention to in a divorce decree, relative to taxes.
Five Tax Considerations in a Divorce Decree
1. The Child Dependency Exemption/Child Care Tax Credit
Divorcing parties generally know that whoever claims their eligible children on their income tax returns can receive a larger income tax refund. Sometimes parties will choose to alternate the years in which one party can claim the children. Other parties will divide their children up and say person A can claim Mary and Joey in all years and person B can claim Daniel and Margo in all years. There are many different ways to allocate the child dependency exemptions. People can really fight hard over these issues. However, it makes sense to talk to an accountant about who would benefit most from claiming the children. It also makes sense to see how claiming the children can affect your bottom line child support obligation. Remember, if a person claims the children on their taxes, that increases their income, which means they have more money to pay support. It is a numbers game. Someone could fight hard for the dependency exemption only to then turn around and pay more in support because of it (though usually the amount is pretty nominal overall, for many people). These are both important things to consider prior to spending time and money arguing over who will claim the children in which years.
2. Taxes Relative to Child Support
In Illinois, child support is calculated using the two parties’ respective net income (which is their income after taxes). Child support is not taxable to the person receiving it, and it is not deductible by the person paying it, at least pursuant to current Illinois law. Child support money is received by the obligee without any concern about it being taxes.
3. Awards of Cash or Property in a Divorce Decree
Cash and property received pursuant to a Divorce Decree is not taxable to the person receiving it and is not deductible by the person paying it. The money and property owned by two parties is presumed to have been earned by them, and thus, they have already paid taxes on it. They paid taxes on it at the time it was earned or received. Thus, when they are divorcing, there is no tax when transferring the property or cash from one of the parties to another. This can be thought of as changing the title to the property; one person is essentially removing their name from it. The other person is retaining what they already owned a share of. Some property settlements, which are tax free, can trigger “recapture” and cause an IRS audit, as well as back taxes. This happens when the property settlement appears to be maintenance, but it wasn’t called maintenance, and thus wasn’t taxed. For property settlement awards, it is important to make sure the amount paid per year won’t cause recapture to occur. This is something to speak to an accountant about to try and avoid any sort of messy unintended tax consequences.
4. Maintenance or Spousal Support (formerly known as Alimony) in a Divorce Decree
Under current law, through approximately December of 2018, maintenance or spousal support is taxable to the person receiving it and deductible by the person paying it, so long as the divorce decree says so, and so long as it was entered prior to December of 2018. After December of 2018, maintenance will no longer be deductible by the payor and taxable by the payee. This is a concerning time in Illinois regarding the issue of maintenance and the changes in the IRS code because Illinois statutory guidelines provide for spousal support to be calculated using gross (pre-tax) figures, and presumes that those sums will be taxable to the person receiving it and deductible by the person paying it. If this is no longer the case, then the Illinois guidelines for maintenance as currently written could cause maintenance awards which are higher than what the Illinois legislature ever intended. There is, however, some judicial discretion allowed under Illinois statutes regarding calculating maintenance, in the mean time, until the issue can be addressed. We will continue to blog future posts regarding changes to this particular issue as they come about.
5. Attorney’s Fees Awarded Pursuant to a Divorce Decree
Monies received by a party as contribution to their attorney’s fees and costs are not taxable in a divorce decree. These monies are marital monies which are being divided between the parties, and thus are not subject to a tax under Illinois law. They just so happen to be used for paying down one of the parties’ debts.
Overall, divorce decrees have many tax consequences. Some are intended, some can be unintended. It is very important to work with a knowledgeable divorce attorney and accountant in crafting your divorce decree to insure there aren’t any unintended surprises.
The attorneys at Anderson &Bobackhave a depth of diverse experience all aspects of family law and negotiating divorce decrees. Please contact Jessica Marshall at Anderson &Boback for questions about this topic and other questions related to Illinois divorce or family law.