Divorce and Taxes

Going through a divorce is difficult and the last thing you want to think about is taxes, but it is important to have taxes mapped out in the divorce decree.  Below are some items to consider when finalizing the decree.

  1. Who will claim the children? Usually, the custodial parent will be the one claiming the children. If it is decided and noted in the divorce decree that the non-custodial parent will be the one claiming the children, then Form 8332 needs to be prepared and signed by the custodial parent.  When filing their taxes, the non-custodial parent will include this form.  The parent claiming the children will be the one that will claim the child tax credit. If you pay medical expenses for your child but do not claim them on the return you can still include those cost when calculating your itemize deduction for medical.
  2. Did assets get transferred during the divorce process? If property is shifted to one spouse, then the receiving spouse does not pay tax on the transfer.  With the transfer, the tax basis will shift to the receiving spouse as well.  Something to consider is when you sell the assets, you will be faced with tax on the appreciation before as well as after the transfer.  For example: you receive several shares of a stock worth $100,000 and cost basis of $50,000 at the date of divorce. You sell all the shares 6 months later when the shares are worth $150,000. Your taxable gain is $100,000.
  3. What happens with the primary residence? If you sell the residence after the divorce and have met the two-year ownership test, you will be able to exclude the gain up to $250,000 if filing as single or head of household.  If you are filing your return as married filing jointly you will be able to exclude the gain up to $500,000. If you sell the residence years later the maximum you will be able to exclude is $250,000.
  4. Are you splitting retirement assets? If you cash out your 401k to give money to your ex-spouse this will be considered a taxable distribution and you will have to pay the tax and early withdrawal penalty on your tax return.  The way to avoid this is to have the transfer accomplished under a Qualified Domestic Relations Order (QDRO), which gives your ex-spouse the right to the funds and relieves you of the tax burden.  You don’t need a QDRO to transfer IRA funds, but the transfer should be spelled out in the divorce decree.  If it is noted in the decree, it will not be treated as a taxable distribution to the IRA owner.
  5. Paying or receiving alimony and or child support? If you pay or receive alimony from a divorce that happened before 2018, you will need to take that into consideration when calculating your adjusted gross income.  Alimony from divorces after 2018 are not included in adjusted gross income. If you pay or receive child support those payments are not taking into consideration when calculating adjusted gross income.
  6. What is your filing status? If your divorce is final before 12/31, you will file your tax return as single or head of household (if you have dependents).  If your divorce is still ongoing on 12/31, you will have to options to file the return as married filing jointly or married filing separately.  If you are filing a joint return, make sure there is an understanding of who will receive the refund, how to split the refund, or liability obligations.  Another thing to remember is you will need to update your form W-4 with your employer so that you are not under withholding once the divorce is finalized.

We understand going through a divorce is a tough process, but if you have any questions relating to the tax implications, please do not hesitate to contact one of our trusted tax advisors.