Every divorce situation is unique, and so are the tax consequences. This overview highlights some essential tax implications to consider if you are considering a divorce. Some tax rules may provide relief, while others might be disappointing. Understanding these financial components will make navigating your divorce easier. Here are the nine most considerable tax consequences of divorce to consider.
- Asset Division
In general, assets transferred as part of a divorce settlement do not result in tax consequences. Property settlements are considered nontaxable events. For instance, if a husband transfers $200,000 from his 401(k) to his wife, there is no tax on that transfer. However, when the wife withdraws from the 401(k), she will incur a tax liability.
- 2018 Changes to Alimony
For divorce orders and separation agreements executed after 2018, alimony is no longer deductible by the payor spouse and is not considered taxable income for the receiving spouse. This change was a significant revision in 2017. However, if your divorce agreement was executed before 2018, you may follow the old law, meaning alimony is deductible by the payor and taxable for the recipient.
- Child Support
Child support is not taxable for the receiving parent and is not deductible for the paying parent. This aligns child support’s tax status with the current status of alimony. Child support is determined based on income, time spent with children, and childcare payments.
- Child Dependency Exemption
Tax law dictates that the spouse with legal custody gets the child dependency exemption. If both parties agree otherwise, they must comply with IRS requirements, including completing IRS Form 8332. A well-drafted separation agreement should address this and ensure proper cooperation.
- Selling Your Home
A couple can generally exclude up to $500,000 of gain from the sale of their primary residence. Gains beyond $500,000 may be subject to tax payments.
- Joint Filing Status
A separated couple can still file jointly if they legally marry on December 31 of that tax year. Coordinating the timing of the divorce filing can require cooperation and planning. If a couple files jointly, each spouse can be held responsible for 100% of the taxes owed.
- Individual Filing Statuses
The tax rate is typically higher than a joint return if each spouse files a separate return. You must file independently starting the year your divorce decree is granted. If you are still legally married, you can file separately as married, but this often results in a higher tax rate. This option is best for couples who are separated, have separate property, and have limited communication.
- Legal Fees
Divorce-related legal fees and court costs are not deductible on tax returns. Factor this into your budget when calculating court-related expenses, as this rule applies universally.
- Audits
One spouse can apply for innocent spouse designation if an audit and back taxes are owed. However, this relief is optional. In 2021, over 26,000 US taxpayers applied for this protection, and less than 5,000 applications were approved. This issue often affects self-employed spouses.
Seeking Professional Advice
A good divorce lawyer will advise clients to consult with a CPA about tax implications, and a competent CPA will recommend seeking legal advice regarding the divorce’s legal consequences. Ensuring accurate and current advice is crucial as tax laws evolve.
The Law Office of Dustin McCrary – Your Trusted Advisor
At The Law Office of Dustin McCrary, we understand the complexities of divorce and its tax consequences. We provide the guidance you need to navigate these challenging times. Contact us today to learn how we can help you make informed decisions and secure a stable financial future.