There’s nothing easy about divorce.
Having been through one himself, Tom knows how difficult and emotionally draining it is. As a CPA, Tom has also seen first-hand the difference a solid tax strategy can make in creating a successful outcome for everyone involved.
When you understand the tax implications of divorce, you can make informed decisions that will save you money and establish a firm foundation for the future.
How to File Taxes During a Divorce
When it comes to divorce and your taxes, the timing matters. The IRS considers a couple married until a final divorce decree or separate maintenance is in place. Once the divorce is finalized, your tax status will change from married to single beginning that year.
If your divorce is finalized on or before Dec. 31st of this year, for example, you most likely will file as single for the following tax year. (If you remarried in the same year, of course, you would once again file as married but with your current spouse.) You don’t need to share a copy of the divorce papers with the IRS, but if the IRS questions your filing status, you will be asked to file Form 14824, which will include a list of specific documentation to provide to demonstrate that you are now single.
If you know a change in your tax filing status is coming, it’s wise to plan ahead. If you work a W-2 job, you’ll want to update the W-4 that you have on file with your employer to ensure you have the proper withholdings. If you are an entrepreneur or investor, work with your tax advisor to ensure you are accurately calculating your quarterly payments.
Where things get trickier is when it comes time to file a tax return and you are in the process of — but not finished with — getting a divorce. The IRS still expects you and your spouse to file and pay taxes on the normal schedule, even when your financial situation is up in the air. It is important to make sure that you properly report all of your assets, including those that are jointly owned, and pay the taxes owed. The IRS will hold both parties responsible for any outstanding taxes.
If you begin divorce proceedings this year but don’t finalize until next year, then you would still file as married when you complete your returns for this year. The exception to this is if you qualify to file as head of household. If you are separated and want to file using the head of household status, you need to meet three criteria:
Your spouse didn’t live in your home for the last six months of the year.
You paid more than half the cost of keeping up your home for the year.
Your home was the primary residence for your dependent children for more than half the year.
If it’s not feasible to work together on a joint return, you and your spouse may need to file separately. There are some key differences between community property states and common law states. In the former, each spouse is treated as receiving half of all of the income, regardless of who earned the income. In the latter, each spouse reports their own income on a married filing separate return. Consult with a CPA who specializes in tax to help you navigate this situation.
What Happens to Taxes When You Divide Property
It’s common to divide retirement accounts, such as 401(k)s or IRAs, as part of a divorce settlement. Generally, when all or part of one of these accounts is transferred from one spouse to another as part of a divorce agreement or court judgment, it does not trigger any additional tax liabilities. Withdrawing money from one of these accounts, on the other hand, creates the same tax liabilities as it would outside of a divorce. Work with your tax advisor to make sure you fully understand the financial situation before finalizing your divorce settlement.
A similar rule applies to other property that is transferred as part of a divorce settlement. Neither spouse will pay taxes on gains or recognize losses on transferred property. However, if a spouse sells the property, that will trigger a possible capital gains tax liability.
How Spousal Support Payments Are Taxed
This is another area of divorce where timing matters.
For divorces that were finalized before 2019, alimony or other spousal support payments are taxable income to the recipient and a deductible expense for the person making the payment. For example, if one spouse pays the other $10,000 in alimony, the recipient must pay taxes on the $10,000. The payer can deduct the $10,000 from their taxes. This can be a significant tax savings for the payer.
For more recent divorces that were finalized in 2019 or after, alimony is not taxable income to the recipient or deductible to the payor. This is a significant change and one you will want to consider before renegotiating any settlements made prior to 2019.
Additional Concerns for Parents of Minor Children
If you and your former spouse have minor children, you have a few additional things to consider when it comes to tax planning.
First, child support payments are not deductible for the payor and are not considered income to the recipient. So, if you are paying child support, you still must pay taxes on the income you use to make the payments, and if you receive child support, you do not need to report the payments as income.
Second, you will need to determine who gets to claim any children as dependents. The government encourages people to have and take care of children by offering several tax incentives. These include the child tax credit, child and dependent care credit, and education credits.
Typically, these tax incentives go to the custodial parent. If you share custody, however, you will want to negotiate who gets to use these credits as part of your divorce and custody agreement. One common approach is to alternate years so that the parents can take turns receiving these benefits. If you go this route, it’s important to work with your tax advisor to make sure your tax planning accounts for the possibility of a higher tax liability in the years when you don’t have access to these credits.
Work With a Pro
The tax implications of divorce can be complex. This is not the time to DIY your taxes. By working with a CPA who specializes in tax, you can start reshaping your long-term tax and wealth-building strategy for the next chapter in your life. The right CPA will serve as a trusted advisor, help you understand the tax implications of divorce and equip you to legally reduce your taxes.
Want help reducing your taxes and understanding the tax implications of divorce? Book a call with TFW Advisors® today to find out how we can help!