Divorce and Tax Consequences – What North Carolina Couples Need to Know
Divorce and taxes are two topics that probably aren’t high on the list of most people’s favorite things to think about. And yet, when you’re going through a divorce, or even contemplating a divorce, considering one means that you will also need to consider the other. Divorce and tax consequences can uniquely impact your taxes in various ways, and it’s essential to understand what that impact might be and how you can best prepare. Even if you and your spouse can cooperate effectively and reach resolutions on various issues quickly, you’ll want to consider the tax implications of those decisions before you make them. Let’s take a closer look at the law together.
Tax Issues Related to Child Support and Custody
Prior to 2018, spousal support, or alimony as it is otherwise known, was tax-deductible for the paying spouse. From 2018 onward, however, that has not been the case. Additionally, the spouse receiving the support does not have to pay taxes on the amount they receive.
Child support is similar in that the spouse who pays the support cannot deduct it, nor does the receiving spouse have to report it. Beyond issues of support, however, it is also important to consider how your custody arrangement itself might affect your taxes.
If you are separated and not officially divorced, you may still file jointly and claim the children on your tax returns. Following a divorce, however, the general rule is that the primary custodial parent (the parent with whom the child lives most of the year) has the right to claim the children on their taxes. While this is generally true, there may be exceptions -for example, if the non-custodial parent has provided more than half of the child’s financial support, they may also be eligible to claim the children.
While this may seem complicated, the good news is that, as with so many issues in a divorce, who can claim the children on their taxes is an issue that couples can discuss and agree upon outside of court, and include in a divorce settlement agreement. Because these issues can be complicated, it is always wise to discuss them with a qualified attorney and a financial advisor, if necessary, to ensure that you make the best decisions for your family.
Taxes and Spousal Support
As a general rule, for spousal support provided in a separation agreement or court order dated after 2018, the spouse who is making the payments cannot take a deduction for those payments. Likewise, the spouse receiving the payments is not required to report those payments as income. This is a change that was made permanently through the Tax Cuts and Jobs Act. Until and unless it is later repealed, this law will apply to taxes and spousal support in the future.
Tax Implications of Property Distribution
As a general rule, pursuant to United States Code Section 1041, there is no tax on property division in a divorce. Nevertheless, there can be hidden tax consequences for certain transactions called capital gains. Sometimes, for example, when certain investments are sold, they result in a capital gains tax. As an example, one spouse may choose to cash out all or part of a retirement fund like a 401(k), with the intention of giving the money to the other spouse in exchange for the house or other property. In that case, the IRS may want to tax the payout.
When considering divorce and tax consequences, it’s crucial to evaluate how property division strategies could affect your long-term tax liability. The good news is that there are certain ways to try to avoid these taxes. One popular way to do so is to obtain a Qualified Domestic Relations Order, or QDRO, for short. After the division of a retirement plan has been agreed upon by the parties or ordered by the court, a QDRO is often the court’s specific order that will direct the administrator of the particular retirement plan to pay a certain amount or percentage of the account to the recipient spouse.
Other Tax-Related Issues
In addition to all of the tax issues related to child custody, child support, and alimony, we commonly receive questions about a variety of other tax-related issues as well. Some of these issues include:
Back taxes
One question that frequently arises following a divorce is who will be responsible for any back taxes the couple may have accumulated during the marriage. Generally, back taxes will be treated like any other debt a couple has, and will therefore be divided according to the terms of equitable distribution that apply to all other marital assets and debts. Certainly, there may be exceptions to this rule, depending upon particular circumstances. Additionally, couples always have the option to address the issue of who will pay back taxes in a settlement agreement that they negotiate themselves.
How to file when separated but not divorced
This is a question that comes up often, particularly because North Carolina requires that a couple be legally separated for at least one year before being able to file for divorce. As a result, there is usually at least one opportunity to file taxes prior to the official divorce. As a general rule, your tax filing status is determined by your marital status on the last day of the tax year, which is typically December 31st. If your divorce has not yet been finalized, you can choose whether you want to file as single, married, or as head of household. Each status has its advantages and disadvantages, so consulting with a qualified financial advisor regarding your particular circumstances is always advised. If able to file jointly, both spouses may take advantage of the same tax credits and deductions for each child. However, it may make more sense to file separately in other instances. Ultimately, consulting with a divorce attorney and a financial advisor will help you determine the best choice for your circumstances.
Post-divorce conversations to have with your employer
Following a divorce, you will most likely have a lower income overall than you did before the divorce and have fewer assets. Depending upon how the divorce affects you financially, you may be in a lower tax bracket when single than you were married. As a result, you may want to file any necessary paperwork with your employer and the IRS to change your withholdings and other information if required.
These are only a few of many tax-related issues and questions that may arise as you contemplate and move through the divorce process. It’s normal and understandable to have questions – after all, tax-related issues can be complicated. The good news is that help is available. You don’t have to face these issues alone. At The Law Office of Dustin McCrary, we’re here for you.
The Law Office of Dustin McCrary – With You Each Step of the Way
At The Law Office of Dustin McCrary, we know that the divorce process can seem daunting and overwhelming, especially when you find yourself at the beginning of this journey, wondering how to begin and what steps to take first. That’s why we’re here to help. We know and understand every aspect of the divorce process, including often overlooked divorce and tax consequences, and are passionate about helping our clients find the best solutions for their situation. Instead of feeling overwhelmed and alone, you can trust that we’ll be there to help you through the process each step of the way. You deserve nothing less. If you’re ready to get started, get in touch with us today. We look forward to helping you soon.