Husband and Wife entered into a Marital Settlement Agreement predicated upon their ultimate judgments of divorce.  If the couple were to enter into a divorce, the provisions of the agreement would be fully incorporated into the final divorce judgment.

The agreement included two provisions regarding their respective rights upon death of the other party with respect to the property of the other.  This included an interest in past, present and future spousal support obligations accepting any obligations set forth in the agreement itself.

The agreement provided that it was binding and shall inure to the benefit of the parties and their heirs except as specifically excluded by the agreement.  Any terms not met would be an obligation of the decedent spouse’s estate.

The agreement obligated the husband to provide a sizeable sum in escrow to his wife upon the entry of a divorce judgment.  This amount would be used to purchase a condominium for her prior to the divorce; the unused balance of the escrow account was to be paid to the wife after the divorce was final.  The agreement also obligated the husband to pay the condominium fees prior to the final divorce judgment.

The agreement also required the husband to pay the wife’s attorney’s fees up to a set amount.

The husband paid as mandated by the agreement and attempted to deduct it as spousal support.  The IRS disallowed the deduction and found that the Marital Settlement Agreement which had been fully incorporated at that point into the final divorce judgment did not support his claim that it was spousal support giving him the benefit of the deduction for those sums paid.  The IRS further found that the agreement, by its terms, caused the escrow account to be an obligation account that would not cease upon the death of the wife and as such was disallowed.  Spousal support cannot continue after the death of either spouse as a matter of law.

If you are in the middle of a divorce proceeding, you may be wondering how you should file your tax return, whether you can claim the children as dependency exemptions and how to determine whether support payments should be deducted or included as income.  The following brief, non-exhaustive summary will help you navigate these issues so that you are well-prepared for your tax appointment.  However, given the complexity of tax laws, it is always a good idea to speak with legal and tax professionals who can analyze your specific situation.

What is my Filing Status?

When deciding how to file, remember that your filing status is determined by your marital status on the last day of the calendar year.  For example, if you filed for dissolution on June 30, 2009, but did not obtain a judgment of dissolution until January 1, 2010, you cannot file as a single person on your 2009 income taxes.

If you are still married, you and your spouse must decide whether you will file your returns jointly (“married filed jointly”) or separately (“married filing separately”).  Generally, the high earner gets a benefit from filing a joint return, however, with a joint return comes joint and several liability, meaning that both spouses are liable for any taxes owed, regardless of who earned the income.   Except in certain limited circumstances, you cannot amend a married filing jointly return to a married filing separate return, so if you have any doubts about how to file, you should err on the side of caution and file married filing separate.

Who Gets to Claim the Kids?

If filing separate returns, you must determine who will claim the children as dependents.  The general rule is that the primary custodial parent will take the exemption, but that parent can release the exemption to the other.  For tax purposes, the primary custodial parent is the one with at least 51% custody.  It is therefore important when entering into a joint 50/50 custody agreement to include a provision that for tax purposes, one of the parties will be deemed to have 51% custody.  When there are two children, you can each take 51% custody of one child and share the deductions.  If there is only one child, you can alternate 51% custody on a yearly basis.   If this is not spelled out in your custody order, the IRS will give the deduction to whoever had the child at least 51% of the year, so parents should keep good records of their actual time with the child(ren) in the event there is a dispute over who is entitled to take the deductions.

Can I Deduct Support I Paid/Is Support I Received Taxable Income?

Another common question is whether support paid or received should be deducted from income of the payor and included in the payee’s income.  The general rule is that the payee’s gross income does not include amounts received for child support, but does include money received for spousal support/alimony.  Similarly, a payor cannot deduct child support payments, but can deduct spousal support payments, which are an “above the line” deduction.  To be deemed spousal support, payments must meet numerous IRS requirements, including, but not limited to, that the payments be made in cash by or on behalf of a spouse under a written divorce or separation agreement or decree.  There are also special rules relating to spousal support and equalization payments made as part of a property settlement; if not properly structured, a payor can lose the right to deduct all spousal support payments made under the agreement.  The IRS rules related to “front loading” are beyond the scope of this article, but should be discussed with a legal and tax professional so that you can structure a settlement that does not trigger this issue.

When it comes to finances, California law treats spouses just like business partners.  In fact, provisions of the California Corporations Code addressing the duties between business partners are incorporated right into the California Family Code.  For example, Family Code 721(b), states that marriage is a “[confidential and fiduciary relationship] subject to the same rights and duties of nonmarital business partners” including an obligation between spouses to provide equal access to all information, records, and books that pertain to the value and character of those assets and debts.  These duties and obligations exist between spouses while they are married and continue through the divorce proceedings and until the date on which all assets or liabilities are actually distributed.  Further, these duties obligate both spouses to provide information even if the other spouse does not ask for it.  Remedies for failure to abide by the disclosure requirements include attorney’s fees as well as an award to the other spouse of 100% of an asset that is undisclosed.

The Fourth Appellate District was recently called upon to visit these disclosure obligations in the case of Marriage of Feldman (2007) 153 Cal. App. 4th 1470.  There, husband failed to disclose several financial transactions during the divorce proceedings, including the purchase of a home and $1 million bond, and the existence of a 401(k) and several other investments.  Wife sought attorneys’ fees and sanctions and was awarded $140,000 in fees and sanctions in the amount of $250,000.  The Appellate Court affirmed.

While the Feldman decision caught the attention of the family law bar and judges alike, this was not the first time a California court upheld a sanctions award based on the failure to disclose.  In Marriage of Rossi (2001) 90 Cal. App. 4th 34, the Court of Appeal affirmed an award of 100% of $1.33 million in lottery winnings, which wife actively concealed during the proceedings, to Husband based on a finding that the concealment constituted fraud and came within the penalty provisions of the disclosure statutes.

The lesson to be learned by Feldman and Rossi is simple:  disclose, disclose, disclose!

As wedding season approaches, you may be wondering whether a pre-nup, or pre-marital agreement, is necessary or right for you.   A pre-marital agreement can provide many benefits, such as protecting your separate property, supporting your estate plan, and establishing rules for deciding future matters during marriage and handling issues such as spousal support and property division should you later divorce.

When considering whether a pre-marital agreement is right for you and your fiancé, consider the following questions.  If you and/or your fiancé answers yes to any of the following questions, you may benefit from a pre-marital agreement.

• Do you own any real estate?
• Do you own more than $50,000 worth of assets other than real estate?
• Do you own all or part of a business?
• Do you currently earn a salary of more than $100,000 per year?
• Have you earned more than one year’s worth of retirement benefits or do you have other valuable employment benefits, such as profit sharing or stock options?
• Does one of you plan to pursue an advanced degree while the other works?
• Will all or part of your estate go to someone other than your spouse?

If you would like to discuss the benefits and procedural requirements of a pre-marital agreement, please contact Lonich & Patton, LLP for a free 30 minute consultation.  Consider issues that you may want to address in your pre-marital agreement, such as separate property identification, decisions about how you will handle money and property while you are married, whether spousal support (alimony) will be paid or waived in the event of divorce, retirement benefit agreements, and agreements about how you want to leave property at your death.

Source: http://family.findlaw.com/marriage/marriage-agreements/prenup-decision.html