Are There Any Tax Considerations in Divorce?

Divorce involves a multitude of complex financial issues.  Most couples are aware of the key financial issues that need to be addressed in a divorce, including spousal support, child support, and division of marital property but they often overlook an equally important element of divorce: the tax considerations.  Ignoring the tax issues associated with your divorce can negatively impact your future financial security.  It’s important to consider the tax implications of your divorce to protect your financial resources as you move forward with your life.

Income Taxes During & After Divorce

Unless your divorce is resolved very quickly, it’s likely that you and your spouse will have to decide how to handle your income taxes while your divorce is pending.  While your divorce is pending your options may include: Married Filing Jointly, Married Filing Separately or Head of Household.  There are some advantages and disadvantages to each filing status that you should be aware of.

• Married Filing Jointly. The advantage to filing a joint tax return is that it will typically permit you to take a larger standard deduction thereby lowering your tax liability and potentially increasing a tax refund.  Consider however, that by filing a joint tax return, you will each be liable for any taxes owed.  If your spouse fails to pay any taxes owed, you could be liable even if you earn less or nothing at all.  Therefore, you will want to reach an agreement with your spouse about how both refunds and tax liabilities will be allocated between you.  A knowledgeable divorce attorney can negotiate these matters on your behalf.
• Married Filing Separately. The advantage to filing separately is that you will only be liable your own taxes.  Filing separately usually results in a higher tax rate.  Filing separately creates some challenges if the couple cannot agree.  For example, if one spouse itemizes deductions, the other spouse will be required to do the same.  Generally, you can only claim deductions for items like property taxes, mortgage interests, etc. if you actually paid them.
• Head of Household. Before choosing this option, you must be sure you qualify.  Generally, you must have lived apart from your spouse in the last six months of the year, paid more than fifty percent of your household expenses, and a child you can claim as a dependent has lived in your home more than fifty percent of the year.  If you can qualify for this filing status, it can offer a higher standard deduction than the Married Filing Separately status.

Once your divorce is finalized, you and your spouse will be required to file taxes separately.  Even if your divorce was finalized on December 31, the IRS will consider you unmarried for the entire calendar year precluding a joint return.  In other words, the Married Filing Jointly and Married Filing Separately tax designations are only available to couples who were married the entire year.

Taxes for Child Support and Maintenance

The amount of child support and maintenance you may pay or receive is often a key issue in a divorce, but whether or not those payments are taxed is sometimes overlooked in the divorce process.    Child support payments are not taxable to the parent receiving them nor are they tax-deductible to the parent making them.

The tax treatment of spousal support or maintenance payments depends on when the support order was entered.  For divorces that were finalized on January 1, 2019 or later, maintenance payments are not taxable to the recipient or tax deductible to the payor, just like child support.  If a maintenance order was originally entered before January 1, 2019, the maintenance payments are tax deductible to the payor and taxable to the recipient.  If your divorce was finalized before 2019 and you later modified your maintenance provisions, it typically will not affect the tax treatment of the maintenance payments.

Property Division & Taxes

Dividing marital property is a key issue to resolve in divorce.  Generally, married couples may transfer money and property from one spouse to the other without incurring any gift tax liability.  (If the receiving spouse is not a U.S. citizen there are some limitations).  While marital property division doesn’t usually trigger any gift tax liability, capital gains taxes may factor into your divorce.

Capital gains taxes are taxes paid on the profit made when selling or liquidating an asset.  If you sell a home, stocks or other investments you may incur capital gains taxes.  Understanding the tax consequences of selling these assets can help you understand the true value to you of any property you may receive during your divorce.

Retirement accounts (including a 401(k), 403(b), IRA, or part of a pension) may be transferred to a spouse during a divorce without incurring taxes.  The transfer should be done pursuant to a Qualified Domestic Relations Order (QDRO).  While properly executed transfers do not trigger tax liability, withdrawals from eligible retirement accounts may lead to both income taxes and penalties depending on who is making the withdrawal.  Generally, the receiving spouse is able to make a withdrawal incident to a divorce without incurring an early withdrawal penalty, but he or she will still incur income tax liability on the funds withdrawn.

Child Tax Credits and Deductions

Divorcing parents will also want to decide who will claim the children as dependents for income tax purposes.  Only one parent may claim as child as a dependent in a given year.   If both parents claim a child it can not only slow down the processing of your tax returns, but it could also trigger an audit and/or claims of tax fraud.  To avoid these unwanted consequences it’s wise to spell out in your marital settlement agreement or other court order exactly who will be permitted to claim your child (or children each tax year).  Taking this step during the divorce process can save you time, money and frustration in the future.

Past Taxes & Divorce

While much of a divorce is focused on preparing for the future, when it comes to the issue of taxes, it’s wise to spend some time looking to the past.  Divorce divides not only income and assets, but also debts and liabilities.  Unpaid taxes and/or improperly filed tax returns may lead to future liability for both spouses. Recall from above, if you filed a joint income tax return, you are liable for the income taxes even if you earned less or had no income at all.  Your marital settlement agreement or other court order should spell out how you and your soon to be ex-spouse will handle any future claims brought by the IRS for unpaid taxes or penalties incurred while you were married.  Failing to take this step can subject you to unforeseen future tax problems.

Contact our Oak Brook Divorce Lawyers

At the law offices of Goodman Law Firm, LLC we work closely with all of clients to break down the complex financial issues they face in ways that permit them to make informed decisions.  We advocate for a just financial settlement that meets their needs.  We can offer advice and explain your options when it comes to dividing and selling marital assets.  Contact our Oak Brook divorce attorneys today to get the help you need with your divorce.