When Getting a Divorce, Don’t Forget Your Taxes
When a major change occurs in the family, the IRS will take an interest. Getting a divorce has tax consequences that frequently come up as an issue. While there are many ways that taxes are impacted by a divorce, here are some of the most significant to keep in mind.
1. Filing status – married or single?According to the IRS, whatever your marital status is as of December 31 of a particular year, this is how you must file your taxes. So, if the divorce is finalized on December 30, then neither party can file as married filing jointly or married filing separately. In some instances, a legal decree of separation can also trigger a single filing status. Since filing status can have a major impact on the amount of taxes owed, some parties agree to extend their marriage into the following year to capitalize on tax savings.
2. Filing jointly or separatelyOnce parties separate prior to divorce, they still have to file their taxes. Married couples have the option to file jointly or separately, and this choice can be remade every year. If there is some spirit of cooperation, the parties consult with a tax professional to determine what is the most advantageous way to file. While sometimes a party feels strongly about filing separately from their spouse, it is worth understanding the financial consequences before making this decision. Bear in mind that there may be liability implications for filing jointly, so it is important to confer with your family law attorney about this issue.
3. Division of the marital estateWhile transferring property between spouses as part of a division of the marital estate is not a taxable event, sale of that property to third parties does have a tax impact. Capital gains or losses realized in the transaction need to be reported. The parties can negotiate the allocation of the burden or benefit based on their respective interests in the property or as part of an overall settlement agreement. In the case of a jointly owned home, a refinance to “buy out” one of the parties also has tax implications since there is an allowable deduction of related expenses.
One particular type of asset requires special treatment: retirement accounts. Ordinarily, withdrawing funds from a retirement account triggers income taxes and penalties. However, if the parties obtain a Qualified Domestic Relations Order (QDRO) from the court, they can furnish it to the institution managing the account and roll the divided assets into new accounts without incurring tax penalties.
4. Support obligationsIn 2017, the major revisions to the tax code changed some significant aspects of spousal support. Currently, the payor of spousal support cannot take a deduction for paying the support, and the payee does not have to treat the payments as income. This law cannot be circumvented in a settlement agreement but spousal support can be adjusted due to taxes. The law does have a sunset provision, so this may change in the coming years.
5. What about the children?Claiming children as dependents depends in part on the custodial arrangement, but if the parties have shared custody, only one parent per year is allowed to take a deduction for each child. Some families choose to resolve this issue by alternating years in which the parent can claim the child as a dependent, or if there is more than one child, then deciding which party can claim which child for the deduction. It is important to make sure that whatever compromise is reached, that the parties include it in their settlement agreement. As with spousal support under the new law, child support payments are not tax deductible.
Juggling all the issues related to divorce can be a real challenge, and it’s important to make sure taxes don’t slip through the cracks. Working with a family law attorney and a tax professional with experience in divorce matters may cause savings and prevent a major, unnecessary tax bill. Are you concerned about the tax implications of your divorce? Contact Reese Law to set up a consultation.
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