The end of a marriage is frequently an emotional time. Many Californians who have gone through a divorce know this firsthand. Alongside the anger, frustration, relief and other emotions comes something most of us would rather not think about, taxes.
Property division is the natural end of divorce and has its benefits and its drawbacks. A sudden and unanticipated tax liability is one of the latter.
Because California is a community property state, all assets and properties accumulated during a marriage are considered community property. Each spouse is entitled to half the total. Assets that each party acquired before the marriage, however, are considered separate properties and are exempt from property division.
There are no additional federal taxes when it comes to the division of most community property and assets. Section 1041 of the Internal Revenue Code allows divorcing spouses to split cash, business assets and properties without having to pay federal income or gift taxes.
Similarly, if one spouse transfers ownership interest of an asset to his or her spouse, the transfer also is essentially tax-free. These transfers may occur before and during final dissolution of a marriage.
Retirement accounts with built-in tax advantages such as IRAs and employer-sponsored retirement plans, however, do not enjoy that same tax-free status. To avoid getting taxed on money going to an ex-spouse, consult someone with tax experience who can figure out the best way to move such funds. Although legal finessing of the tax code may seem like a lot of trouble, avoiding a big tax bite may be worthwhile in the end.
Financial matters like tax issues are often more complex than the emotional issues people usually consider with divorce.
Source: MarketWatch, “What’s even worse than divorce?” Bill Bischoff, Dec. 3, 2013