Cross-Border Matrimonial Matters
In a purely domestic context in the U.S., it is not uncommon for a spouse to cross state borders in search of a jurisdiction where he or she has sufficient ties to find the most favorable state law in which to file for divorce.
In the global economy, it is more and more common for foreign nationals living in the U.S. to review their options in various countries around the world.
It is important for the parties to the marriage to be aware that the U.S. has a very well developed set of rules that can trigger unforeseen tax consequences when a marriage is terminated.
Many of the somewhat otherwise equitable rules that apply in the purely domestic context can actually result in a tax liability when non-residents are involved. These surprises usually occur when alimony/child support payments are made to a party who is no longer a U.S. resident taxpayer.
For example, a transfer of appreciated property to a non-resident as part of a divorce settlement can trigger a U.S. income tax, payable by the transferor. The reason behind this is because when property is transferred between resident spouses, the IRS will receive taxes paid at the time the transferred property is sold later on. When the recipient spouse is a non-resident, there is no obligation for them to pay taxes when they sell the property. Therefore, as per IRC §1041 (d), when property is transferred from a U.S. resident to a non-resident, taxable gain is imposed on the transfer and must be paid by the transferor.
Furthermore, alimony payments to a non-resident are subject to a 30% withholding tax (absent treaty relief). Alimony is a court-ordered payment stemming from a divorce. Generally, the higher earning spouse pays alimony to the lesser earning spouse, the purpose of which is to help maintain the same lifestyle and comforts received during the marriage. When the payor of alimony is a U.S. resident and the recipient is not, the payor is required to withhold 30% of the alimony as U.S. source income tax. In order to do this, the U.S. resident payor must request and be provided from the non-resident recipient, a taxpayer identification number via a form W-8. The taxpayer identification number will be used to fill out and file forms 1042 –Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and 1042-S –Foreign Persons U.S. Source Income Subject to Withholding. In the past, any alimony payments paid were deductible to the payer and taxed as income to the recipient. This is going to change on December 31, 2018. If the divorce was finalized before December 31, 2018, payers will still be able to deduct alimony payments, and recipients will still have to pay income taxes on them, even those payments received after December 31st. For all divorces finalized after December 31st, alimony payments made will no longer be deductible, and payments received will no longer be taxable to the recipient.
My firm can help you avoid these unpleasant surprises and others with advance planning.