PLANNING FOR TAX ISSUES AT DIVORCE IS MORE IMPORTANT THAN EVER
Question: My lawyer and my husband’s lawyer suggested that we put a hold on our divorce until after the first of the year because the new tax law that was just passed could help us financially. We are going to sell our house; we have one child in college now, and another who will start next year. How can the new tax law help us?
Answer: If you are divorcing, your advisors are wise to suggest that you consider the beneficial opportunities now made possible by the Taxpayer Relief Act of 1997 before you ink the final settlement. Although there are a number of changes, those most likely to affect divorcing individuals include: (1) the ability to get money more easily from IRA’s to pay alimony and support; (2) reduced capital gains tax rates which make low basis property more valuable; (3) a more valuable dependency exemption; and (4) a more valuable marital home due to a new exclusion for capital gains for homes sold after May 6, 1997. If you are selling a home and educating children, at a minimum, it appears that you and your husband may be able to benefit.
In the past, the dependency exemption oftentimes was not worth fighting over; however, changes in the tax law have increased the value of the exemption under certain circumstances. In addition to a yearly tax credit for each child under age 17 that begins in 1998 of $400 per child for 1998 and $500 per child thereafter, parents can take advantage of new educational expense credits which may result in savings of thousands dollars for each child who attends college or graduate school. But there is a catch: divorcing parents can utilize these generous tax credits if -- and only if – the parent is entitled to the "dependency exemption." This creates real potential value in the dependency exemption.
In the past, divorcing parents sometimes agreed to transfer the exemption from the custodial spouse -- who is entitled to the exemption -- to the non-custodial spouse -- who has the higher tax bracket so he or she could take advantage of greater tax savings. But this should not be done if the non-custodial spouse’s income is high enough to cause a phase out of the exemption. And, to further complicate matters, the new credits phase out at lower income levels than does the exemption. This means that a parent’s total tax may be less if the exemption remains with the custodial -- or lower tax bracket -- parent under certain circumstances. For these reasons, calculations should be made on a case-by-case basis.
Before May 6, 1997, in order to avoid capital gains taxes on "principal residences," the selling spouse (or spouses) were required to roll over their gain into a new home (or homes). But if one spouse moved out of the home before the sale and the home was no longer considered to be his or her "principal residence," that spouse would not be able to qualify for the rollover and would be taxed on the gain. And for those 55 or older at the time of the sale, a one-time $125,000 exclusion from capital gains was available; however, because it was a "one-time" benefit, many difficulties arose, especially with second marriages where the new spouse also owned a home.
Since both of these complex provisions were repealed by the new law, the home has become a much more valuable asset because each spouse involved in the divorce will be able to exclude up to $250,000 of gain from the sale of the marital home from taxation. And, to make matters even simpler, the home need not be a spouse's "principal residence" at the time of the sale -- just during two out of five years before the sale. And if one spouse moved out while the other continued to use the residence as his or her "principal residence" according to the terms of a divorce decree or separation agreement, the spouse who moved out will be able to "count" this time and still qualify. And instead of the one-time "55 or over" exclusion during a lifetime, the new law allows a larger exclusion with no age requirement that can be used every two years, not just once in a lifetime.
Bottom Line: Careful tax planning is essential at the time of divorce. To find out more, visit http://www.flyingsolo.com and click on "Divorce and Separation" and then "Divorce Tax." To receive "Taxes and Divorce," an 84 page understandable publication about practical tax planning for the divorce lawyer and client, including a ten page supplement that explains the 1997 tax rules, send $17.95 payable to "Divorce Tax" and we’ll make sure you receive your copy.
Jan Collins is an award-winning writer and editor. Jan Warner is a matrimonial, elder, and tax attorney. Both are based in Columbia, South Carolina. Flying Solo is seen in newspapers throughout the United States and can be found on the Internet at http://www.flyingsolo.com.
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