Divorce Settlement Tax

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The different aspects of a divorce settlement like alimony, child support and capital gains are handled in varying manners when tax is to be calculated.

Divorce Settlement Tax Facts

Alimony

Alimony received as a result of a divorce settlement is taxable income. Thus, if a payee receives 60,000 USD, after payment of the tax, the payee is left with 42,000 USD. This is due to the 30 percent marginal state and federal tax bracket.

The spouse who pays alimony is eligible for a tax deduction. If a payer pays 60,000 USD and is in the same tax bracket as above, then it would cost the payer 42,000 USD.

Child Support

The Child Support payments are not deductible for the payer. Similarly, they are not taxable for the recipient.

Capital Gains

The subtraction of the cost of an asset from the fair market value is called as the Capital Gain. Thus, if a person purchased a house for 100,000 USD and the present value of 125,000 USD, then the capital gain is of 25,000 USD. Such a calculation is applicable for other assets like investment funds, mutual funds or any other asset that has appreciated.

In 1997, the Federal Government issued rules that alleviated the onus of income tax burden on the residence. As per these rules, if a person has resided in a house for minimum 2 years out of the previous 5 years, then a 250,000 USD capital gain exclusion per divorcing partner is permissible.

Now, assume that a house is to be sold and the gain in value is more than 250,000 USD. In order to take complete benefits of the total 500,000 USD exemption, the divorcing partner must sell this house prior to the divorce.

In other words, if the house is sold before or during divorce procedure, up to 500,000 USD of the capital gain is tax free. After the divorce is complete, just 250,000 USD is tax free for the recipient.

Divorce Settlement Tax Example

Consider a divorcing couple, Jack and Linda who have 2 children.

In the year 2009, Jack's income was 135,000 USD and Linda's was 40,000 USD. Before the divorce was finalized, Jack's income after payment of tax was 91,000 USD and Linda's was 34,000 USD.

Now, let us see what would be the incomes if the following divorce settlements were made.

Divorce Settlement 1

• Jack disburses 5,000 USD to Linda as alimony. This is deductible
• Jack disburses 20,000 USD to Linda as child support. This is non deductible
• Jack's income after tax amounts to 68,000 USD
• Linda's income after tax is 58,000 USD
• The combined income of the divorcing couple is 126,000 USD

Divorce Settlement 2

• Jack disburses 18,000 USD to Linda as alimony. This is deductible
• Jack disburses 7,000 USD to Linda as child support. This is non deductible
• Jack's income after tax amounts to 72,000 USD
• Linda's income after tax is 56,000 USD
• The combined income of the divorcing couple is 128,000 USD

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