In the case of a trust, the increase in value only includes trust growth and income that is actually available for withdrawal. In other words, the initial value of the trust or inheritance is preserved from equitable distribution, and will not be divided between spouses unless it is retitled in joint names or commingled with marital property.
To add further protection, many spouses wisely enter into prenuptial agreements that protect the increase in value of trusts and inheritance in divorce. In fact, for high net worth families, a prenuptial agreement is a common part of a wealth succession and estate plan. Divorce and taxes are two of the main obstacles when high net worth families plan to transfer wealth to future generations, so it makes sense to deal with both issues together.
Many people inherit real estate, or retirement accounts, that may have built-in tax liabilities. For inherited real estate, the beneficiary receives a stepped-up tax basis, which is the value of the property when the grantor died. When the property is sold, income tax may be assessed on any gain from the date of inheritance to the date of sale, if the beneficiary did not use the property as a residence for two of the last five years prior to sale. Advance planning is the surest and most effective way to ensuring that trusts and inheritance are preserved, but even if it is too late for a prenup, there are some effective strategies available.
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The agreement also provided:. Each party accepts the provisions herein made for him or her in lieu of and in full and final settlement and satisfaction of any and all claims or rights that either party may now or hereafter have against the other party for support or maintenance or for the distribution of property.
However, each party has relied upon the representations of the other party concerning a complete and full disclosure of all marital assets in accepting the property settlement, and it is understood and agreed that this provision shall not constitute a waiver of any marital interest either party may have in any property owned but not fully disclosed by the other party as to existence or fair market value at the time this agreement is executed. Moreover, the failure of either party to disclose property shall constitute a material breach of this agreement, which shall give rise to whatever remedies at law or in equity may be available to the other party.
At some time after the parties signed the agreement, Ms. Smith began asking Mr. Smith whether all assets had been disclosed. She also hired an attorney to pursue claims arising from nondisclosure of assets. In , Mr. Smith realized that he had inadvertently failed to disclose to Ms. According to the terms of the agreement, Ms.
Smith had not waived her marital interest in the stock options. Pursuant to a settlement or an amendment to the original agreement , Mr.
Find out how marital property is divided in a Pennsylvania divorce case.
Smith paid Ms. In considering this issue, Mr. Smith expressed concern that the transfer to Ms. Smith would exhaust his unified transfer tax credit and create a taxable gift transfer. However, because Mr. Smith made the payment pursuant to a written agreement relative to their marital and property rights, and Mr.
Smith divorced within the three-year period beginning one year prior to the signing of the agreement, under Sec. Smith was not subject to gift tax on the transfer and did not have to use his unified transfer tax credit. Certain payments to third parties on behalf of the spouse—for example, mortgage payments—qualify as payments in cash. If the parties are married at the end of the tax year and file a joint return, payments made during the year do not qualify as alimony.
Thus, there is inherent tension between property settlement and alimony. The payor may want a low property settlement and high alimony amounts for the tax deduction. The payee spouse, however, wants the reverse—that is, a property settlement not includible in income rather than taxable alimony. Tax advisers can help their divorcing clients by reviewing any nonuniform payment schedule to make sure it does not violate the anti-front-loading rules. In planning for the division of assets and the obligations of the parties, safeguards can be put into place to avoid failed expectations.
The parties may contract to leave the ex-spouse as beneficiary hanging beneficiary on life insurance policies and retirement plans to ensure that the ex-spouse receives his or her bargained-for interests. Safeguards also may be needed when a payor spouse has cyclical income business interests or illiquid business interests; the spouses may agree that an alimony trust or maintenance trust Sec.
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An alimony trust can protect the payee ex-spouse from the death or financial insolvency of the payor before all of the payments have been made. Spouses in divorce situations must disclose all property, and this property must be distributed to the proper party. When fraud, errors, or omissions occur, a CPA needs to be capable of helping his or her client avoid the negative tax consequences of transfers or payments made in connection with the divorce.
Among the many tax practice resources the AICPA makes available to Tax Section members see Resources box at the end of this article is an eight-page checklist of tax considerations for CPAs representing clients who are divorcing or recently divorced. Some of its points are:. Since divorcing spouses are likely to have competing interests, however, CPAs providing these services should take care to avoid conflicts of interest.
In the nine community property states, property is owned concurrently between spouses. Property transfers by a spouse during a period of marital strife may be subject to heightened judicial scrutiny in an equitable distribution of property. A court may invalidate transfers made to deprive the other spouse of assets by fraud or dissipation.
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A transfer incident to divorce from one spouse to the other generally will not result in taxable gain or loss. However, divorcing couples should be made aware of requirements in the Code and regulations for a transfer to be considered incident to divorce. Similarly, alimony typically entails tax planning. Ray A.
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Breaking News. Feature TAX. Tax considerations when dividing property in divorce Marital estate division offers challenges and opportunities for advisers. Additional aspects of an equitable distribution that should not be overlooked include: Every asset acquired during the marriage and not covered by an agreement is subject to division.
The name on the asset title or the source of the money used to acquire assets is not controlling. The parties to the divorce have the burden of identifying and proving the existence of assets. One spouse may prove to the satisfaction of the court that the other spouse transferred assets with divorce in mind and have an equal amount of assets awarded to him or her.
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Each spouse is responsible for any debts incurred during the marriage. The agreement also provided: Each party accepts the provisions herein made for him or her in lieu of and in full and final settlement and satisfaction of any and all claims or rights that either party may now or hereafter have against the other party for support or maintenance or for the distribution of property.
The payments do not continue after the death of the recipient. The provisions of the instrument do not preclude a deduction by the payor spouse and the recognition of income by the payee spouse. Spouses who are legally separated under a decree of divorce or separate maintenance do not live in the same household when the transfer is made. Divorce Issues Checklist Among the many tax practice resources the AICPA makes available to Tax Section members see Resources box at the end of this article is an eight-page checklist of tax considerations for CPAs representing clients who are divorcing or recently divorced.
Some of its points are: Determine which party to represent and prepare a new engagement letter, privacy disclosure notice, power of attorney, and similar documents. Consider obtaining conflict-of-interest releases where indicated. Review any prenuptial agreement. Consider the effect of joint liability for any taxes owed.