Montana Divorce and TaxesMarybeth Sampsel
Because divorce proceedings generally consist of transfers of property, assets or liabilities from one spouse to the other, it is necessary that we keep in mind the possible tax consequences. Before I explain some of the basics, be warned. I am not an accountant, nor am I a tax attorney. I strongly urge anyone who is in the process of divorce or considering a divorce to meet with an accountant to discuss tax issues.
With that said, there are some basic rules that generally apply in divorce cases. As you learn throughout the divorce process, there are exceptions to nearly every rule – which is why it is so important you meet with an attorney and accountant. But generally, most assets between you and your spouse can be divided without any federal income or gift tax consequences. This is called a tax-free transfer and is governed by Section 1041 of the Internal Revenue Code. Tax-free transfers can happen during the divorce process are at the time the divorce is finalized. Sometimes, transfers are made well-after the divorce is finalized. For example, it can often take several months to transfer certain kinds of assets. Provide the transfer is made incident to the divorce, the transfer is likely to be a tax-free transfer. “Incident to divorce,” is defined as those transfers that occur within one year after the date of dissolution (i.e. finalization date) or within six years after that date, as long as the transfer is made pursuant to a divorce agreement or order.
Keep in mind, however, that even when a tax-free transfer rule applies, there may still be tax implications for you or your ex-spouse. For example, if you wind up owning an asset and you sell it for more than it was worth when you received it, you are probably on the hook for the taxable gain. In other words, when you are the one who ends up with an appreciated asset, you are going to get stuck paying the tax liability that comes with it.
The tax-free transfer rule generally does not automatically apply to those kind of assets that already come with a tax-advantage (i.e. IRA’s or employer-sponsored retirement plans). By jumping through a few extra hoops, you may be able to transfer those assets without tax consequences. With certain retirement accounts, the court may issue a Qualified Domestic Relations Order (commonly known by the acronym QDRO). With a QDRO, each spouse ends up being responsible for the taxes on their share of the retirement account.
If your marital estate consists of significant assets, I strongly encourage you see an accountant during your divorce to be sure you are getting accurate tax advice.