How Income Taxes Affect Property Settlements
Almost all divorce property settlements are affected by current or deferred income tax liabilities. The court can consider tax liability issues in two ways:
"Courts have generally found that consideration of tax consequences is either required or at least appropriate where the consequences are immediate and specific and/or arise directly from the court's decree, but find they are not an appropriate consideration where speculation as to a party's future dealings with property awarded to him or her would be required." ( A.L.R. 5th 568, page 16) The question then becomes, what tax liabilities would qualify under this "immediate and specific and/or arise directly from the court's decree" standard?
Current tax liabilities arising from transactions that have already happened clearly fall into this category. Additionally, any near term tax liability from any anticipated disposition of marital property should fall into this category. This would include any tax liability generated by a court ordered property settlement. Any other type of deferred tax liability would not likely qualify as a direct reduction of marital property.
Tax liabilities that should be considered as a factor in the equitable division of marital property
Under the Colorado property statute CRS 14-10-113, the court divides marital property in such proportions as the court deems just after considering all relevant factors. One such relevant factor in many high net worth cases is the deferred taxes on marital property.
"The purpose of considering tax consequences is to strive for a fair and equitable distribution of marital assets to both parties. One party should not be charged with the full value of an asset that is burdened with an inevitable payment of taxes. The effect of the burden should be considered so that neither of the parties gains an unfair advantage or suffers an unfair burden because he or she receives a particular asset in distribution." (In Re Marriage of Vaccaro, 677 So. 2d 918: 1996 Fla. App. LEXIS 7469) Clearly, not considering deferred taxes in a distribution of marital property could result in an inequitable distribution of martial property. How then, can parties to a divorce assist the court in reaching an equitable distribution that takes deferred taxes on marital property into account?
"A party who demands consideration of the tax consequences of receiving a tax burdened asset should demonstrate good faith by assisting the trial court in consideration of the tax consequences of all the tax-burdened marital assets, whether or not the demanding party is to receive those particular assets. It is only through the presentations of the consequences as to all assets that the trial court may order a distribution that is equitable." (In Re Marriage of Vaccaro, 677 So. 2d 918: 1996 Fla. App. LEXIS 7469)
In theory, if the court chooses to award any tax-burdened asset directly
to either spouse, it should consider the overall tax burden that is being
allocated to each party and adjust the equitable distribution accordingly.
To determine the overall burden allocated to each spouse, the court would
need a schedule of the tax consequences of each marital property asset
to be distributed. Once the total tax consequences of a particular property
division are calculated, the court can then award additional marital property
to the party suffering the larger deferred tax burden. Since the actual
process of equalizing the tax burdens and benefits to each party on an
asset by asset distribution can be a complicated and cumbersome process,
practitioners are well advised to make clear and well reasoned presentations
to the court.