This article is designed to address the tax consequences of certain divorce related actions, such as spousal maintenance and property division. This area is very complex and nuanced, and while we will provide a broad framework for the tax implications related to divorce, should you need specific information or have questions about your situation, please consult your lawyer or a tax specialist. In fact, we advise that you consult a tax adviser even in straightforward cases, just so you will not experience any unexpected tax consequences.
Maintenance Exemption and Deduction
Maintenance payments are exempt from the receiver’s income tax if the payments are made to a person who is or has been a spouse of the one paying maintenance, to or for the benefit of a child of the payer, or to or for the benefit of a child of the other party to the marriage. This exemption extends to maintenance received by a de facto spouse, as well. The general rule is that there is no tax assessed on maintenance received.
The exemption will only apply to payments attributable to the maintenance payer – and not in situations where the payer makes the payments to divest himself or herself of an income-producing asset, or to divert ordinary income that would otherwise be taxable. Essentially, the exemption will not apply if the payer is not acting improperly.
With regard to deductions, the maintenance payer may not deduct maintenance payments from his salary or wages; spousal maintenance may not be claimed as a tax deduction.
The tax that is sure to rear its head in the property division area is the capital gains tax. Capital gains taxes are triggered upon the happening of a capital gain event, which can be a gain or a loss of assets. There are more than 50 events enumerated in the Income Tax Assessment Act (ITAA), and they range from the disposal of a capital gains tax asset to the grant of an option or lease.
Certain assets and transactions are exempt from capital gains tax, including vehicles (that carry less than 1 tone and hold less than nine passengers), trading stock, and the disposal of a life insurance policy by the original beneficial owner of the policy. The right to payment from a superannuation fund or other approved deposit fund is also excluded from capital gains tax.
Capital gains and losses related to the dissolution of a marriage or de facto relationship are exempt from capital gains tax.
The law also provides for certain roll-over relief for transfers between spouses. For instance, if your former spouse transfers an asset with capital gains tax attributes, the roll-over relief allows you to take it as the transferor had it (with the same capital gains tax attributes). Additionally, if an asset was a personal use asset to the transferor, it will be considered a personal use asset to the transferee as well, and special rules apply to calculating capital gains for these assets.
There are specially carved out rules with regard to dwellings and capital gains taxes. Particularly if the main residence is used for business purposes as well – in this case a special exemption to capital gains tax will apply.
Superannuation, specifically the splitting of superannuation, carries it’s own tax implications. For instance, if one surrenders their rights to payment out of this type of fund, the capital gains tax provisions will not apply. Additionally, when dealing with splitting certain tax concessions like roll-over relief can apply. Moreover, certain public sector funds will even have untaxed elements or other schemes not subject to tax.
With the lengthy list of exemptions and complexity of capital gains tax law, sometimes it is necessary to make decisions as to how you and your spouse plan to treat certain capital gains tax assets. For instance, you will have to decide which dwelling will be considered the main residence, or you may chose to nominate multiple dwellings as the main residence. These choices you make will certainly have tax implications and thus should be decided prior to any transfer. Typically parties agree to these choices by signing a statement prior to transferring the property, but bear in mind that once a choice has been made, it is binding and cannot be changed or altered later.
Legal costs can also result in tax implications. They are considered in part of a capital gains calculation as incidental costs related to disposal or acquisition of a capital gains asset. These costs should be considered separately from the asset, and should be treated differently. Additionally, money spent on legal or tax advice might be deductible under the ITAA.
The court is given broad discretion with regard to property orders and has the power to alter property interests as it sees fit. However, the court is to consider the implications of capital gains taxes that will arise if a party is forced to dispose of property by order of the court.
Certain exemptions and concessions under capital gain tax law may be available if a property order causes a capital gains tax event to occur. For instance, an order requiring the transfer of property may trigger the marriage breakdown roll-over relief provisions.
As you can imagine the tax implications that can arise through divorce are boundless. The law is very complex; this article is merely intended to give you an idea of the implications and consequences so you may be prepared to address these issues with regard to your specific situation.