Prior to filing for divorce, various federal tax considerations should be reviewed due to their potentially profound implications. Among the major issues commonly covered in a divorce decree or agreement are: alimony, sometimes referred to as “spousal” or “separate maintenance” support; division of property; and child support. Each has its own tax treatment and implications.
Division of Property
Most divorces involve a division of the property owned by the couple. Such a division of property is not usually a taxable event, i.e., neither owes taxes nor gets a deduction from income because he or she receives certain property as a result of the divorce.
There are, however, tax implications following divorce that affect future taxes. More specifically, selling personal and real property in the future may require spouses who received such property (pursuant to a divorce) to pay taxes in connection to that property.
Parents of Injured Children and Recovery of Consortium Damages
Although “loss of consortium” damages are traditionally associated with spousal relationships, modern cases have extended the right to recover them to parent-child relationships. Referred to as “filial consortium damages,” these awards are intended to compensate the parent for the loss of affection, love and companionship that results from a child’s injury or death.
Wrongful Death Actions Distinguished
In cases where parents sue for the wrongful death of their child, most jurisdictions permit parents to recover filial consortium damages from the wrongdoer. Parents can generally recover these damages under the state’s wrongful death statute.
The situation is much different, however, in cases where the child survives. Under these circumstances, although the child may have suffered severe permanent injuries, state law varies significantly with respect to the availability of filial consortium damages. As a general proposition, most states do not recognize parents’ claims for lost consortium when the child survives.
Majority of States: No Filial Consortium Damages for Non-Fatal Injuries
A majority of jurisdictions do not permit parents of non-fatally injured children to recover filial consortium damages. The following examples reflect the status of the law in several states:
- In 2003, the Texas Supreme Court declined to extend a claim for loss of consortium to the parents of a child with a non-fatal injury. As such, Texas does not permit parents to recover loss of consortium damages resulting from a child’s serious injuries.
- In 1988, Michigan’s highest state court held that a parent has no cause of action for loss of consortium damages when a child is negligently injured. However, the parent is still entitled to sue for loss of services as well as medical expenses.
- In 1986, the Wyoming Supreme Court similarly rejected a parent’s right to consortium damages resulting from serious injuries to a child.
Some States Allow Parents to Recover for Non-Fatal Injuries
A substantial minority of jurisdictions authorize parental recovery of consortium damages for injured minor children. In some states, parents may recover under a statute which expressly sanctions such damages. In other states, however, parents must rely on case law and judicial interpretation to recover filial consortium damages.
Though not an exhaustive list, the following states permit a parent to recover loss of filial consortium for non-fatal injuries:
- A Massachusetts statute sets forth the following rule: “The parents of a minor child or an adult child who is dependent on his parents for support shall have a cause of action for loss of consortium of the child who has been seriously injured against any person who is legally responsible for causing such an injury.”
- In 1994, the Florida Supreme Court expressly ruled that a parent has a common law right to recover for loss of an injured child’s consortium, stating “The loss of a child’s companionship and society is one of the primary losses that the parent of a severely injured child must endure.”
- In 1986, the Arizona Supreme Court granted parents the right to recover consortium damages from a third party who permanently injures their adult child. The court expressly refused to limit loss of consortium damages in severe injury cases to cases involving minors: “Loss of consortium is a compensable harm, and we see no basis for limiting this action solely to cases of wrongful death [and] no reason for limiting the class of plaintiffs to parents of minor children when the parents of adult children may suffer equal or greater harm.
Tax Issues Relating to Qualified Domestic Relations Orders and Divorce
An increasingly large portion of the assets of married couples consist of rights to payments and stock from pension plans. In many states such assets are subject to division during a divorce. Divorce and division of property are generally controlled by state law, but pension plans are controlled by federal law in many respects.
Absent a QDRO, the amount withdrawn from the plan thus becomes income and/or capital gains to the plan participant, not the former spouse. If a valid QDRO is in place, however, the distributions from the plan are treated as income and/or capital gains to the alternate payee/spouse. However, if distributions from the plan are used to satisfy child support or payments to some other dependent of the plan participant/spouse, the distributions are still treated as taxable to the plan participant/spouse for federal income tax purposes, notwithstanding the existence of the QDRO.
Divorce mediation, an alternative to traditional divorce proceedings, is a means to resolve the complex issues of a divorce. Mediation involves the services of a trained and neutral person who works with the parties to facilitate the settlement of disputed issues. Such person is known as the "mediator."
In traditional divorce proceedings, the judge ultimately determines child support, child custody, spousal support and property issues. Mediation, on the other hand, allows couples to control the outcome of their divorce. Additionally, the mediation process is non-adversarial in nature, which is especially important for couples with children, as like-minded parents can establish parenting plans with minimum disruption to the lives of their children.
Marital Settlement Agreements and Life Insurance Policies
Many marital settlement agreements require one party to maintain a life insurance policy on his or her life naming the former spouse as the primary beneficiary. While this provides some financial security for the former spouse, it may also result in an adverse unintended tax consequence for the insured spouse's estate.
For example, if the ex-husband is required to maintain a $1 million life insurance policy on his life, naming his ex-wife as beneficiary, on the ex-husband's death his ex-wife will receive the $1 million face amount of the policy directly from the life insurance company. If the ex-husband was the owner of the life insurance policy and paid the premiums on the policy, the IRS will include the $1 million face amount of the policy in the ex-husband's estate for the purposes of calculating the amount of estate tax owed by the ex-husband's estate. If the ex-husband died in 2007 with a taxable estate of $3 million plus the $1 million in life insurance, the inclusion of the life insurance proceeds would result in a $450,000 increase in the estate tax owed.
The foregoing result may be avoided through the use of a tax-sensitive marital settlement agreement and an irrevocable life insurance trust. The ex-husband may still be required to maintain a $1 million life insurance policy with his ex-wife as beneficiary, but the life insurance policy would be owned by the trustee of the irrevocable life insurance trust. The ex-husband may transfer money to the trust for the payment of the premiums. Since the payments are required pursuant to a court order, the payments are not considered taxable gifts. Since the irrevocable life insurance trust, not the ex-husband, is the owner of the policy, the $1 million life insurance policy will not be included in the ex-husband's estate for the purpose of calculating the estate tax owed.
Pension Plans and ERISA
Divorce and division of property are generally controlled by state law. However, when state law contradicts or is inconsistent with federal law, the federal law "preempts" the state law; federal law controls the outcome. In 1984, Congress passed the Employee Retirement Income Security Act (ERISA), which governs most private pension plans (government and some other plans are not covered).
Federal law prohibits the assignment of pension benefits in ERISA plans. This appeared to include transfers to a spouse during divorce, regardless of a state court decision on division. To remedy this, the Retirement Equity Act of 1984 (REA) established an exception to the rule through use of a "QDRO."
Today, couples seeking a divorce have options to consider outside of traditional legal proceedings. Parties to a divorce are becoming increasingly aware of the expense, time and emotional toil of adversarial litigation, and are looking to options that better suit their financial and emotional needs. The following three options are alternatives to traditional divorce proceedings that mesh alternative dispute resolution with traditional lawyering skills to settle a divorce.
Your Illinois Divorce
WHAT TO EXPECT ABOUT YOUR ILLINOIS DIVORCE
What are the Legal Issues Involved in Ending a Marriage
In the U.S., a divorce* is the means by which the marriage between a couple is legally terminated. A judgment for divorce means that the parties have reached an agreement or, if the parties cannot agree, a judge has made a decision regarding the children of the marriage (custody, support, and visitation) and the couple's financial affairs. Following a divorce, each party is free to remarry and is also able to resume a former (maiden) name.
Other issues to consider before the divorce is final are the needs for medical insurance or life insurance; obligations on a mortgage if one party stays in the marital home; and tax implications of property division or financial awards.
*The law in Illinois now uses the word "dissolution" rather than "divorce." In order to be clear and consistent, this pamphlet will refer to the process as "divorce."
Today couples are looking for alternatives to litigation, in the administration of their marital dissolution. In traditional divorce matters, a judge will ultimately decide the divisions of property, spousal support, child custody and child support.
Many couples now seek to be more involved in the resolution of the divorce issues. One alternative dispute resolution method by which spouses can gain more control over the process and outcome of their divorce is through an advisory opinion.