Tax Implications of Divorce and What You Can Do
For tax purposes, a couple is considered married if their decree of divorce has not been finalized by December 31. Thus, the year that it is finalized is the year that most tax changes will take effect. However, if you consider the tax implications during the negotiation period, you and your spouse can make decisions that will minimize the tax impact and result in greater savings for both of you.
Some of the changes that take place in divorce that will have an effect on your taxes include:
- Change in filing status: Married filing jointly, married filing separately, single, head of household
- Losing the house
- Paying or receiving alimony or spousal support
- Custody of dependents
- Dividing or transferring non-liquid assets
- Dividing or transferring marital assets
- Spousal buyout of home or family business
With planning, many of these taxation issues can be negotiated or handled in a way that minimizes the tax disadvantages. As one spouse benefits in one area, the other spouse might negotiate a benefit in another area.
Filing status: Look at the different tax effects with each filing status. Often, if there is great disparity in incomes, the spouse with the greater income would be hit the hardest when filing separately. If you choose “married filing jointly” before the divorce is finalized, you may want to have a tax attorney review your spouse’s reporting, because you will be jointly responsible for any errors or intentional misreporting.
Family home: The family home is usually a source of mortgage interest and property tax deductions. The spouse who gets the home would receive these deductions and the other spouse would lose them. If the house is sold and the profits divided, both would lose the tax deductions and would pay taxes on the capital gains from the sale. These effects need to be calculated when deciding what to do with the house.
Alimony: Normally, the one who receives alimony or spousal support must claim it as ordinary income, while the one who pays may deduct whatever is required in the settlement. Additional voluntary payments are not deductible. Alimony is taxed or deducted in the year that it is paid.
There is a wrinkle in this, however: for those who finalize their divorce or separation after December 31, 2018, alimony will no longer be tax deductible for the paying spouse, nor will recipients be required to declare alimony as income. This law does not affect those who are divorced prior to that date, unless both parties agree to a modification of their divorce agreement.
Child custody: The primary caregiver automatically receives the child deduction. However, the parent with primary custody can negotiate giving the deduction of some or all of the children to the other parent. This could allow more money to be available for child support, or it may offset the benefit the custodial parent receives in another area, for instance, tax deductions for keeping the house.
Non-liquid assets: 401(k)s, pensions, and other retirement plans or non-liquid assets can be divided between spouses, but special paperwork must be filed. Different assets require different forms, usually either a certified divorce decree or a Qualified Domestic Relations Order. Check with the asset’s administrator to make sure you have the right documentation and that it is written in such a way as to avoid tax penalties. How much each spouse receives can be part of the negotiation process.
Spousal buyout: Sometimes a spouse may buy out the other spouse’s equity in a home or business and pay in installments. This can be done tax-free only if the payments are defined as “incident to a divorce” and completed within six years of the divorce decree.
Transfer of marital assets: While the transfer of liquid assets is usually tax free, the subsequent sale of those assets can have significant effects on taxes. Spouses need to consider carefully what they will do with the assets once divided, and if planning to sell, negotiate an even distribution of the tax burden.
Divorce is usually a stressful time for both parties, and making decisions that consider tax implications is an additional concern. Talk to us about how your settlement will affect your taxes in Year 1 of your divorce and beyond. We can help you preserve as much of your assets as possible to benefit you and your family.
Law Office of Elissa C. Goldberg
107 North Broad Street, Suite 211
Doylestown, PA 18901