Divorce is a complex process that not only impacts your personal life but can also have significant tax implications. Depending on the couples involved, navigating a divorce can be an emotional experience. It can also be an poignant for their tax advisors, particularly when the advisor has a long history with both spouses. Continue reading for six tax issues to consider if you are getting divorced:
Tax Issues if Getting Divorced
Tax planning issues to consider if assisting clients in getting a divorce sometimes includes conflict-of-interest matters. After these matters have been resolved, the tax advisor should swiftly meet and address tax planning issues, including the following.
01 | Filing Status
Your marital status as of December 31 of the tax year determines your filing status for that year. If you’re legally divorced by that date, you must file as “single” or “head of household” (if you qualify). For those still married on December 31, you can file jointly or separately. Choosing between “married filing separately” or “married filing jointly” can affect your tax rate, deductions, and credits. So, it’s important to evaluate both options with a tax professional.
02 | Alimony and Spousal Support
Recent tax law changes have significantly affected the tax treatment of alimony. For divorces finalized after December 31, 2018, alimony payments are no longer tax-deductible for the payer. Nor are they taxable income for the recipient. However, for divorces finalized before this date, the payer can continue to deduct alimony, and the recipient must report it as income. Understanding these changes is critical when negotiating spousal support.
03 | Child Custody and Tax Credits
Tax issues if getting a divorce when children are involved offers credits for the primary caregiver. For example, the parent who has primary custody of the child usually claims the child as a dependent. This parent may also qualify for valuable tax credits like the Child Tax Credit or the Earned Income Tax Credit. However, in some cases, the non-custodial parent can claim the child as a dependent if both parents agree and fill out the necessary forms (IRS Form 8332). Therefore, it’s important to clarify this in your divorce agreement.
04 | Division of Property
The division of marital property can have serious tax implications. Particularly regarding the transfer of assets like real estate, stocks, or retirement accounts. Transfers between spouses as part of a divorce settlement are generally tax-free. However, if you later sell those assets, you could be liable for capital gains taxes. This is especially relevant for assets like a home or investments that have appreciated significantly over time.
05 | Retirement Accounts
Dividing retirement assets, such as IRAs or 401(k)s, can lead to tax consequences if not handled properly. A Qualified Domestic Relations Order (QDRO) is often necessary to transfer funds from a retirement account without triggering taxes or early withdrawal penalties. Without a QDRO, the transferring spouse could face taxes and penalties. Consequently, it’s essential to follow proper procedures to avoid unnecessary costs.
06 | Deductible Legal Fees
While the general legal costs of a divorce are not tax-deductible, there are some exceptions. Legal fees directly related to obtaining taxable alimony or protecting income-producing assets may be deductible. It’s important to keep detailed records and consult a tax advisor to determine whether any part of your legal fees qualifies for a deduction.
Conclusion
Facing tax issues and their implications if getting a divorce can be overwhelming. For instance, your filing status, alimony, child custody, property division, retirement accounts, and legal fees. For these reasons, understanding the issues surrounding these matters can help you make informed decisions. Consulting a tax professional is always recommended to navigate these complex issues efficiently.
You may also enjoy reading: Qualifying For Innocent Spouse Relief
