Divorce Tax Implications

When a marriage breaks down, taxes may be the last thing on anyone’s mind. However, the tax impact should not be underestimated. Here are some important tax implications of divorce and how to deal with them.

Tax Filing Status
Filing status is the first thing that needs to be determined. If the divorce has not been finalized by Dec 31, the couple will need to determine whether they should continue filing a joint return, or should choose to file separately. Filing joint tax returns may result in lower taxes for both spouses. However, doing so also means that each spouse can be held responsible for the taxes and any interest and penalties due.
After the divorce is final, individuals may be able to file as “head of household” if they can claim a dependent who lives with them in their home, provided it is the dependent’s main residence and the individual pays for more than half of the home’s maintenance for at least half the year. “Head of household” offers a more favorable tax treatment than filing as “single, ” but only one of the ex-spouses may file as head of household.

Marital Property Settlements
Property acquired by the spouses during their marriage (e.g., family home, retirement plan assets) generally qualifies as marital property. In all ordinary cases, spouses do not owe any taxes for property transfers due to a divorce. Ex-spouses have one year from the date of the divorce to settle up their assets with no tax implications. In this case, the IRS treats any property transfers as a non-taxable gift.
Also, one of spouses can buy out of the house without triggering any capital gains. Divorce law considers paid share of home’s value as marital transfer. This allows them to collect the home’s sale price without paying taxes on it.

Forensic Accounting
When a divorce involves a complicated or troublesome financial situation, divorce lawyers often seek the advice of forensic accountants. These experts commonly help with valuation issues in high-asset divorces. A forensic accountant can help if spouses own a business, have multiple investments, have stock options, trusts or complex finances. Additionally, forensic accountants can determine “hidden assets” or income and play an important role in equitable distribution of assets.

Dependents
It’s important to understand who can claim dependents, as only one of the parents can do it. This will affect tax credits that can be claimed. It’s presumed that a parent who has physical custody of a child for most of the year is entitled to claim the Child Tax Credit. However, the exemption can be traded back and forth between each parent from year-to-year by filing an additional form. It’s possible to structure the divorce agreement fairly, by alternating who gets the credit each year or by splitting multiple dependents between spouses.

Child Support and Alimony Payments
Courts typically require one parent to pay child support so that the parent with primary custody isn’t solely responsible for maintaining the children’s standard of living. Child support payments are considered outside the tax system for both the recipient and payer. Child support is not deductible and isn’t considered income.
Payments made under a divorce or separate maintenance decree may be deductible as alimony if the divorce agreement is dated prior to January 1, 2019. This applies only if the payments qualify as alimony for federal tax purposes. Voluntary payments made outside a divorce or separation decree aren’t deductible. Alimony received from a former spouse is taxable in the same year if the divorce agreement is dated prior to January 1, 2019. Alimony is not subject to tax withholding so estimated tax payments should be increased to avoid a penalty.

As taxes can get complicated during a divorce, it’s important to seek professionals. Similar to having an attorney to help you through your divorce, financial planners and accountants should be part of your empowerment team to ensure you maximize your post-divorce assets and minimize the taxes. Don’t hesitate to contact Dimov Tax Associates at the contact form below.