When a couple chooses to end their marriage, they will need to address a wide variety of financial matters, and they will need to make decisions about how to handle multiple types of divorce-related tax issues. However, there are many situations where couples separate before getting divorced, either as a trial to determine whether to move forward with ending their marriage or in preparation for their final split once the divorce process is complete. 

When a couple is living separately while they are still legally married, they will need to address certain types of unique tax issues. The decisions they make during this time may be based on how they expect to handle matters during their divorce, or they may need to take temporary measures to ensure that both parties’ financial needs are addressed properly. It is important for spouses to understand their rights and options when addressing these matters, since decisions that may be beneficial for one spouse may lead to financial difficulties for the other.

Tax-Related Matters to Address During a Separation

Couples who file tax returns while separated will need to determine whether they will file jointly or separately. While filing a joint tax return may provide some benefits, such as a lower tax rate and the ability to claim certain credits, spouses should be aware that they will both be liable for any taxes that are owed, as well as any tax debts or penalties uncovered during a subsequent IRS audit. 

Virtual currencies have represented a significant investment opportunity for many people over the last several years. Because of the increased level of financial activity surrounding cryptocurrency, the IRS has begun to pay closer attention to these transactions to ensure that investors are paying the required taxes. 

In the past, some cryptocurrency investors have treated transactions in which one type of virtual currency was traded for another as “like-kind” exchanges, which would allow them to defer capital gains taxes on these transactions. The Tax Cuts and Jobs Act of 2017 disallowed the use of tax-free exchanges for personal property in 2018 or later. However, some investors may have used these types of exchanges for transactions that took place before 2018, and they should be aware that they could potentially face tax audits and be required to pay taxes that apply to these transactions.

IRS Guidance on Pre-2018 1031 Exchanges for Bitcoin, Ether, and Litecoin

Since they are addressed in Section 1031 of the IRS tax code, like-kind exchanges are often referred to as “1031 exchanges.” The IRS recently released a memo addressing whether certain types of cryptocurrency transactions qualify as 1031 exchanges. In this memo, the IRS noted that in 2016 and 2017, Bitcoin and, to a lesser extent, Ether, were used to facilitate transactions involving other virtual currencies, since these currencies could be more easily converted to and from U.S. dollars. A person would usually need to acquire Bitcoin or Ether before trading for other virtual currencies, or someone who wished to liquidate another cryptocurrency they owned would usually need to trade their currency for Bitcoin or Ether first.

The coronavirus pandemic has affected many people’s finances, but fortunately, different forms of relief have been made available from federal and state governments. While this has provided many people with benefits allowing them to meet their financial needs, it may also complicate certain matters. Couples who are going through a divorce will need to determine how COVID-19 relief may affect them, including whether they will be able to receive stimulus payments and claim tax credits. When addressing issues related to divorce and taxes, it is important to work with an attorney who can explain the laws and ensure that the decisions made are financially beneficial.

COVID-19 Stimulus Payments and Tax Credits 

Most people received multiple stimulus payments in 2020 and 2021 that were meant to address the ways that the COVID-19 has affected the national economy. These payments were treated as “recovery rebates,” and they functioned as a prepayment for tax credits that could be claimed when filing an annual tax return. The initial stimulus payment for individuals with an income of $75,000 or less was $1,200, and married couples who earn less than $150,000 received $2,400. Families were also able to receive a stimulus payment of $500 for each dependent child. Additional stimulus payments of $600 per individual were sent out in December 2020 and January 2021, and a third stimulus payment of $1,400 per individual, plus up to $1,400 per child, was sent in March 2021.

Couples who got divorced in 2020 or 2021 or who are currently involved in the divorce process may need to address issues related to these stimulus payments and tax credits. Typically, stimulus payments received while a couple was married are considered marital property, and they will need to be included in the property division process. If any stimulus payments were not received, they may be claimed as credits on a tax return, and a couple’s divorce decree may specify whether a spouse may be able to claim these credits or whether they will divide tax refunds for 2020 or 2021.

Divorcing couples often need to address complex financial issues, especially if they will be dividing multiple types of property, assets, and debts. In addition to determining how they can divide all of their marital property fairly and equitably, couples will also need to understand how the decisions they make will affect their tax obligations. When addressing issues related to divorce and taxes, including gift taxes, it is important to work with an attorney who understands how tax laws apply to property settlements.

Divorce Settlements and Non-Taxable Gifts

When a person makes a gift of money or property to someone else, gift taxes may apply, and a gift tax return may need to be filed. However, in most cases, transfers of property between spouses either before or after their divorce are exempt from gift taxes. Typically, these transfers will be considered non-taxable gifts if they fall into one of the following categories:

• Property transfers that are ordered in a divorce decree, including property settlements made before completing a divorce that were incorporated into a divorce decree.
• Property transfers made through a written agreement between the parties, including transfers meant to provide financial support for the couple’s children. These types of transfers must take place within 1 year before or 2 years after the date the agreement was executed.
• Property transfers made to settle marital support rights, such as a monetary lump sum paid in return for a waiver of the obligation to provide spousal support. Gift taxes will not apply to these transfers so long as the amount of money or property transferred is not larger than the value of the spousal support rights.
• Property transfers made before the finalization of a divorce that qualify for the marital deduction. This deduction allows spouses to transfer property to each other without being subject to gift taxes. However, this deduction does not apply to certain types of transfers, including transfers of some types of interests in trusts, as well as transfers to a spouse who is not a U.S. citizen.
• Property transfers that qualify for the annual gift tax exclusion. As of 2021, a person may exclude gifts to another person totaling up to $15,000 each year. For property transfers to a non-U.S. citizen spouse, the annual exclusion is $157,000.
• Property transfers involving direct payments for medical care or tuition made on behalf of a person’s former spouse.

Contact Our San Jose Tax Law Attorney for Gift Taxes and Divorce

Even though most divorce cases will not involve gift taxes, spouses will want to be sure to understand how the decisions they make about property division will affect their tax obligations. At John D. Teter Law Offices, we can review a proposed divorce settlement and identify any tax issues that may affect you, and we will advise you on the best ways to avoid paying unnecessary taxes or address outstanding tax debts. For legal help with divorce-related tax issues, contact our San Jose, CA tax lawyer at 408-866-1810.

Couples who have decided to end their marriage will need to address a wide variety of financial issues. During this process, spouses will not only want to make financially advantageous decisions, but they will need to consider how these decisions will affect their taxes. One divorce-related tax issue that may arise involves determining how taxes will apply to child support or spousal support payments made by one party to the other.

Taxes on Support Payments

In the past, child support and spousal support were taxed differently. The person who paid spousal support was able to deduct these payments from their taxable income, and the person who received spousal support was required to report these payments as part of their income and pay taxes on the amount received. Child support was handled differently, with the payor not being allowed to deduct payments, and the payee not reporting payments as income. 

The tax laws changed a few years ago, and for divorces that were completed on January 1, 2019 or later, spousal support and child support are taxed the same. Payors of support cannot deduct payments, and payees are not taxed on the payments they receive. This may make the consideration of tax-related issues during divorce more straightforward. However, those who are currently paying spousal support from a divorce that was finalized before 2019 will still be able to deduct these payments, and they will want to be sure to understand how the decisions they make will affect their taxes going forward.