A lot of people don’t like the IRS. There are lots of little gotchas that can put people on the hook for large sums of money. Sometimes these hit during a divorce, and sometimes much later when split property is cashed out. It depends on the asset in question.
In most cases, when there is a transfer of assets under a divorce settlement the government treats it as a gift between spouses for tax purposes. This means they’re both immune to income tax and to the gift tax. The government really doesn’t want to get involved in taking away money when a split happens. However, if the spouse is a nonresident alien then it is taxable, so be careful of this if it applies!
What about less tangible assets like stock options? Since Washington is a community property state, your ex-spouse could take part of them in a divorce if you got the options after you got married. Luckily, the IRS also has a hands-off approach here too. In a nutshell, any stock options transferred to the non-employee spouse will be converted to nonqualified employer stock options. This transfer is also considered a gift and no income tax applies.
Later, if the non-employee spouse does exercise those options they will be on the hook for any taxes and withholdings from the money made. This will not affect the other spouse’s taxes.
Do you have a question about how your property will be divided up in a divorce settlement? If you live in Washington, call Elise Buie Family Law Group, PLLC for a consultation about your situation. We’ve helped many couples come to fair settlements in their divorces.