Property Division & Taxes: The Basics

When a marriage is dissolved, the spouses must distribute all marital assets and property between them. Most asset divisions will not result in a tax event. That is because the IRS devised a provision that allows transfers from one spouse to another that occur following a divorce to complete without taxes. As a result, they can transfer a lump sum settlement from a savings or checking account tax-free. Vehicles, jewels, and additional personal goods are also exempt from taxation.

However, certain marital assets immediately generate tax ramifications, which may be expensive if not managed properly. Retirement accounts, for example, are intentionally created like that. If you withdraw from them early, you will face a significant tax penalty. So, yes, IRS regulation about divorce transfers without tax fees exists. But still, if a divorced spouse withdraws cash from their retirement fund to donate to their ex-spouse, they will surely suffer tax implications.

Spouses must manage retirement accounts with care so they can bypass tax fines when moving an IRA. They need to follow the procedure for transferring or rolling over the money to some other retirement account. Other types of retirement funds are more difficult and need additional actions to avoid tax fees. To guarantee that an eligible workplace account, like a pension or 401K, goes through without taxes, the spouses have to get a Qualified Domestic Relations Order.

Stock option transfers can also be complicated since the IRS regards statutory stock options differently from non-statutory stock options. A spouse can realize a capital gain when they exercise non-statutory stock options. However, that is not the case with statutory stock options. 

Parties may simply agree on a financial value for the options once they are exercisable. That way, the non-owning spouse can receive that sum as a lump settlement. The alternative is to put a clause in the court order or divorce agreement stating that the employee-spouse who holds the options shall retain them on behalf of their ex-spouse till they are exercisable.

Putting the marital house up for sale as a result of the divorce might also result in tax complications. The spouses may need to pay capital gains taxes, depending on the circumstances.

The main message is that ex-spouses should know that asset division may be complex and expensive if done incorrectly. To ensure that neither partner has to face taxes, both parties should analyze the tax implications of each transfer and ask a professional if they have any questions.