Deciding to divorce can be an emotional journey for many couples. Despite the emotional toll the ordeal can bring, it’s still important to make an effort to learn as much as possible throughout the process. With key strategies in place, your family can walk away from the divorce as financially stable and economically whole as possible.
For most people, this means thinking about how marriage dissolution will impact your taxes and what you can do to minimize any tax-related adverse effects ahead of time. Like divorce, taxes can already be a daunting undertaking for many individuals. That’s why it’s especially crucial to reflect on how the various aspects of a divorce settlement can have an effect on your taxes.
How Does Divorce Affect Taxes?
You and your former spouse can greatly benefit from learning how a divorce can affect your tax returns and benefits. It’s important to consider which deductibles are applicable, how to avoid heavy taxes or penalties, and when a result of a settlement agreement may be subject to taxation, among other issues. Of course, every marriage and divorce is unique, so it’s also critical to consider all of these things in the context of your own circumstances so you can choose the right strategy earlier rather than later.
Filing Taxes Before and During Divorce Proceedings
Until your divorce or legal separation is finalized, you and your spouse must submit your tax return as a married couple. Spouses considering divorce should understand that they most often will save money if still able to file jointly, which is only possible when still legally married. Married couples who file jointly are typically allowed certain tax breaks and other benefits on their taxable income, including deductions and preferable tax brackets that are revoked upon the decree of divorce or legal separation. After the divorce is finalized, your tax liability as an individual will likely increase.
One option that may be advantageous for some couples to consider is to prolong the official divorce decree until you can file as “married filing jointly” for the last time. This can help minimize your tax burden as well as allow for more flexibility during the final stages of the divorce settlement. However, this is not always a viable option or ideal for every couple, so be sure to evaluate all implications of the arrangement.
If you and your former spouse choose to file jointly, you will also be susceptible to any tax liabilities or penalties your partner may incur, meaning your spouse’s financial choices have consequences on your taxes. Consult with an attorney if you are concerned your spouse may cause financial harm or participate in unlawful activity.
Another feasible option could be living separately (or legally separated), whether before a divorce or not. When this is the case, you may be eligible to file as “head of household” due to being technically married but filing separately, which can yield numerous benefits and further options.
Tax Changes After Divorce Is Finalized
Once legally separated or officially divorced, you and your former spouse must file separately and can no longer file jointly. After the divorce has gone through, you must give your employer a fresh W-4 (Employee’s Withholding Certificate) within 10 days.
It should be noted that individuals who pursued annulments are required to file an amended tax return for every tax year that was impacted by the annulment. In other words, you must file a new tax return for the years of marriage that are now rendered void.
In addition, anyone who has changed their name after separating must be sure to notify the Social Security Administration of the change. Otherwise, you must file your tax return with the name the SSA has on file.
There are more complex issues that can affect your post-divorce tax returns, as well, including alimony, the division of assets and debts, the sale of assets, and child custody.
Back Taxes and Alimony Payments
Support payments from one spouse to the other mandated in a divorce or separation agreement are known as alimony or spousal maintenance installments. For agreements signed in 2019 or later, alimony payments are not deductible on the providing party’s tax returns. Agreements signed in 2018 or before render the installments deductible by the paying party, and the payments are also included as part of the receiving spouse’s income.
Back taxes, money the spouses owe to the IRS from previous years, are to be split up after divorce or separation. This can be done by filling out IRS Form 8857. Each spouse pays according to their individual taxable income, assets, and deductions, which means that back taxes are not necessarily split 50/50. If your former partner earns more money, they will most likely need to pay a larger share of the back taxes.
Transferring and Dividing Assets Between Divorcing Spouses
The IRS typically does not consider the transferring of assets between spouses during divorce as a taxable event. As a result, the exchange of assets between separating spouses is tax-free because there is no recognized loss or gain in the property exchange.
This is true as long as it’s established that the transferring of marital property was incident to a divorce. Property transfer incident to a divorce means that the property transfer occurred within one year of the marriage dissolution or is related to the end of the marriage. This can be proven by providing a certified divorce decree.
It is important to know that accumulated or non-liquid assets, such as pensions, stocks, bonds, and IRAs, can be subject to significant taxes and penalties if spouses attempt to divide them. Accumulated or non-liquid assets include your retirement account, which is considered marital property; thus, your spouse is entitled to a portion of the funds.
To minimize taxes and avoid penalties, spouses holding these types of assets can benefit from a Qualified Domestic Relations Order. A QDRO is a court order that outlines how retirement benefits will be distributed in the future, allowing distributions to proceed as if you and your former spouse are still married. Both parties are ensured they receive their rightful benefits.
Taxes Related to Selling the Marital Home
The most valuable jointly-owned asset in the vast majority of divorces is the marital home. During divorce proceedings, spouses often sell the house and split the proceeds, either immediately or sometime in the future. Alternatively, one spouse may buy out the other’s property interest. The profits from selling the marital home are subject to capital gains taxes. but this can be avoided for qualifying spouses who plan ahead accordingly.
Capital gains tax can be bypassed if the house sale proceeds are reinvested within two years. For this benefit to apply, the home must have been a primary residence of one of the spouses for at least three out of the previous five years. Qualifying for this option is worth considering during divorce negotiations because if the settlement allows one spouse to live in the marital home for two years or longer before it is sold, the other spouse not residing there can lose their eligibility to avoid the capital gains tax.
Joint Child Custody and Claiming Dependents on Taxes
The IRS mandates that only one divorced parent may claim a child who qualifies as a dependent on their tax return; co-parents cannot share or split the tax benefits on their respective returns. It’s important you and your ex-spouse know who will claim your child; if you have multiple children, it’s important to determine who will claim which children. Separate filings that claim the same dependent will slow down the IRS’s processing of your return as the IRS determines which claim takes priority.
Generally, the custodial parent – the parent with whom the child lived for more nights total throughout the year – claims a qualifying child as their dependent. A custodial parent qualifies to claim a child if they’re legally separated or divorced or if they have lived apart from their spouse consistently for six months during the tax year. Additionally, the child must have been financially supported by and primarily living with the parent for at least six months. If your co-parent illegally claims your child on their tax return as a noncustodial parent, be sure to consult with a tax professional.
For parents with joint custody, meaning the child spent an equal number of nights with each parent during the year, the person with the higher adjusted gross income would be considered the custodial parent and may claim the child on their tax return. Please note that it is possible for the noncustodial parent to claim a child as their dependent. The custodial parent can submit Form 8332, which would release their claim to the dependency exemption. Furthermore, regardless of the custody arrangement, only the custodial parent can take the child care credit, and both parents can deduct medical expenses related to their child.
FAQs About a Divorce’s Impact on Taxes
Divorce can be a complicated process, especially considering the changes the proceedings will have on your financial future and your taxes. We answer some common divorce tax questions below.
Our Divorce and QDRO Attorneys Are Ready to Help with Your Case
With the help of the professional divorce attorneys here at The Valley law Group, you don’t need to stress about the financial and technical burden of divorce. Together, we can ensure your vulnerable assets, such as retirement accounts and property, are distributed fairly and equitably.
Contact us today for more information or to schedule your free consultation.
Sources:
- Journal of Accountancy. (2013). Tax ramifications of divorce. Retrieved from https://www.journalofaccountancy.com/issues/2013/apr/20126248.html
- Internal Revenue Service. (2022). Publication 504: Divorced or Separated Individuals. https://www.irs.gov/publications/p504#en_US_2022_publink1000175857:~:text=make%20the%20change.-,Head%20of%20Household,-Filing%20as%20head
- Internal Revenue Service. (n.d.). Filing taxes after divorce or separation. Retrieved from https://www.irs.gov/individuals/filing-taxes-after-divorce-or-separation#:~:text=The%20IRS%20considers%20you%20married,of%20divorce%20or%20separate%20maintenance
- Social Security Administration. (n.d.). Change your name on your Social Security card. https://www.ssa.gov/personal-record/change-name
- Internal Revenue Service. (n.d.). Alimony and separate maintenance payments. https://www.irs.gov/individuals/filing-taxes-after-divorce-or-separation#:~:text=Alimony%20and%20separate%20maintenance%20payments
- Internal Revenue Service. (n.d.). Form 8332: Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. Retrieved from https://www.irs.gov/pub/irs-pdf/f8332.pdf
Jonathan Roeder, Founder/Director of Marketing of The Valley Law Group, is an Arizona native who has dedicated his life and career to the service of others. After graduating salutatorian of his high school class, Jonathan attended beautiful and prestigious Pepperdine University, where he majored in Political Science. During his tenure at Pepperdine University, his passion for helping others grew after securing a clinical position with a residential treatment center for juveniles with substance addictions. Post-graduation, Jonathan returned to Arizona and served as a residential manager for mentally and physically disabled homes.