Most divorcing couples come to the table knowing that division of assets, time with children, and money are all areas central to reaching a settlement. Others are aware that they also need to address questions pertaining to health insurance coverage and even life insurance.Few, however, consider the tax implications of their agreements.
At the Centre for Mediation and Dispute Resolution, we suggest that all agreements need to include consideration of tax implications, lest you realize tomorrow that the agreements you reached do not provide you with the moneys you anticipated at the time of settlement.
Here is a sampling of areas with tax implications, which should be considered, where applicable, in your divorce settlement:
I. Child-Related Taxes:
II. Real Estate Sales
III. Investment Gains and Losses
IV. Retirement Funds
V. Life Insurance Policies (w/Equity)
Be aware that ordinary income taxes will be incurred on the cash received from surrender of policies if the amount of the premiums paid is less than the amount of the cash surrender value.
VI. Term Life Insurance
Typically, payouts from term life insurance policies are not considered income.
VII. Transfer of Property
Transfers of assets in divorce generally constitute a tax-free transfer to the recipient. Retirement funds can also be transferred from one spouse to the other without any tax implications provided that the funds stay in tax-deferred retirement accounts.
It is important to note that the terms of your agreement can result in a taxable event unintended by the parties. Therefore support payments need to be structured with full awareness of the tax pitfalls and implications under various situations. Moreover, understanding that tax laws may change over time suggests that your agreement incorporates provisions for future review and modification of terms. It is perhaps worth noting that the various provisions of the 2017 Tax Cuts & Jobs Act will “sunset” at the end of 2025. What will happen in 2026 is anyone’s guess.
These examples constitute only a smattering of the many tax implications inherent in each couple’s divorce settlement. In order to protect both spouses from unpleasant surprises, it is crucial for both parties to understand what they are receiving and what they are really giving up in fashioning their agreement. Often parties can create better, more beneficial agreements, by “giving” to their spouse in areas that will not have a negative impact on their own settlement. The problem-solving element of mediation presents an ideal forum for analyzing tax implications and weighing their “value” to each party…. In the end, the parties’ agreement should focus on tax savings and advantages to be achieved by both parties sharing the common goal of optimizing the “goodness” of their agreement for the family.