Tax Implications of Divorce: What You Need To Know Before Filing

Our latest blog covers essential tax tips for recently divorced individuals as they file this year.

Divorce is a significant life event that comes with emotional and financial complexities. One of the most important, yet often overlooked, aspects of divorce is its impact on taxes. Understanding the tax implications can help individuals make informed decisions, minimize potential liabilities, and navigate their new financial realities. In this post, we will explore the key tax considerations after divorce, including changes in filing status, spousal support (formerly known as alimony), child support, and property division.

Filing Status

Your filing status will determine, in part, how much tax you owe, what credits you are eligible to claim, your standard deduction amount, and even whether you will get a tax refund. Most often, your filing status correlates to your marital status. While you were married, you likely filed taxes with your former spouse as “Married Filing Jointly” (‘MFJ’). During your divorce, you may have filed as “Married Filing Separately.” Now after your divorce, you will most likely file as either “Single” or “Head of Household.” The IRS maintains definitions of each filing status and how to know which is right for you. It’s important to expect that those filing under a filing status other than MFJ will likely have a higher tax burden than those in MFJ tax brackets. If you are concerned about which filing status is most appropriate for your unique situation, we recommend contacting your tax or accounting professional.

Spousal Maintenance (Alimony)

Paying or receiving spousal maintenance (formerly known as alimony) is a common outcome in many divorces and there are tax implications on both sides. If your divorce was finalized prior to 2019, maintenance payments are deductible by the payer spouse and includible in the recipient spouse’s income. However, with the onset of the Tax Cuts and Jobs Act[1], this has been upended. Now, in divorces finalized in 2019 or thereafter, you can’t deduct alimony or spousal maintenance payments you’ve made to your ex. And if you receive spousal maintenance or alimony, you don’t add those payments to your gross income, meaning they are non-taxable.

The tax treatment of pre-2019 spousal maintenance agreements can vary if there has been a modification of the divorce agreement, but only if the modification expressly states the repeal of the deduction for alimony payments applies to the modification. This provision is important to keep in mind when negotiating a modification to spousal support payments. An experienced divorce attorney can help you navigate a modification agreement and ensure appropriate tax treatment for spousal support payments.

Child Support

Child support payments are never deductible for the parent paying the support and are never considered income for the parent receiving the payments. There have been no changes to this long-standing tax principle.

Dependent Tax Credits

“Who gets to claim the kids as dependents on their taxes?” This is one of the most common questions divorce attorneys hear from clients during tax season. And the answer is: it depends. Often, this is answered in your Marital Settlement Agreement and is incorporated into your final divorce decree. If this wasn’t settled in your Marital Settlement Agreement, or your agreement is silent on the issue, you can reach out to one of our experienced divorce attorneys who can help you negotiate the issue or litigate if necessary.

Other child-related credits or deductions you may be eligible for post-divorce include the Child Tax Credit and the Child and Dependent Care Tax Credit. To claim the Child Tax Credit of up to $2,000 per child, you must meet certain eligibility requirements and include a Schedule 8812 when you file your taxes. The Child and Dependent Care Tax Credit allows taxpayers to take a credit for some of the costs paid for child care. For more information on how to qualify and claim the Child and Dependent Care Tax Credit, you can review materials provided by the IRS or contact your accounting or tax professional.

Marital Property Division

In general, property division between spouses as a result of divorce proceedings is not taxable. So, the transfer of real estate into one spouse’s name, for example, is likely not a taxable event. However, if assets are sold during or as a result of divorce proceedings, a taxable event has occurred and the person receiving the proceeds of that sale will be liable for the resulting capital gains tax. Often, Marital Settlement Agreements will address which spouse is responsible for any taxable gains, if any, resulting from the sale of assets during or as a result of divorce proceedings.

 Retirement Assets

If you’ve received a 401(k) or IRA settlement as a result of your divorce, you probably are concerned about the tax implications of that transfer. If the money you received was transferred pursuant to a Qualified Domestic Relations Order (“QDRO”) from your former spouse’s retirement account into a retirement account in your name, there will be no tax due on the transfer. However, if you took a transfer from your spouse’s retirement account into a non-retirement account in your name, this is considered a “withdrawal” for tax purposes and will be subject to tax penalties. Typically, the spouse receiving the transfer will be responsible for any resulting tax obligation.

Business Interests

If either you or your former spouse owns a business, those taxes are relevant for a host of reasons during and after divorce. Profits from a business are taxed, and business taxes are relevant for determining income for child support or spousal maintenance purposes. Gains and losses may be untaxed and/or need to be carried forward or back, which can greatly impact the final income determination for support purposes. Accurately reporting business income is imperative for determining ongoing child support and/or spousal maintenance. For help reporting your business income, we recommend contacting your accounting or tax professional.

Deceit

In the sometimes-tumultuous world of divorce proceedings, deceit by a spouse is a common concern. One spouse may hide assets during the division of marital property, or the spouse who is responsible for filing tax returns could underreport income on behalf of one or both spouses. If your ex-spouse does this, it can have devastating consequences for your tax bill. If the IRS believes one spouse is innocent of wrongdoing, that spouse can be relieved from liability so long as the following criteria are met:

1. The couple must have filed a joint tax return.
2. The innocent spouse must have had a good faith belief that the correct taxes were paid.
3. The spouse who prepared the tax return underreported income.
4. When the tax return was filed, the innocent spouse was unaware of the underreported income.
5. The rules of fairness would not be upheld if the innocent spouse is responsible.
6. The tax relief request by the innocent spouse must be applied for no later than two years from the first time the IRS tries to collect the deficiencies.

An individual who meets the criteria for innocent spouse relief will be relieved of all responsibility for the entirety of the taxes owed, along with the penalties and the interest, or could only offer relief for a portion of those taxes, penalties, and interest. We strongly recommend contacting a tax attorney that can help you with your request for relief if you believe this may apply to you.

Keep these tips in mind as you work to prepare your taxes as a recently-divorced person. Your divorce may have impacted your tax obligations in ways you weren’t aware of. If you’re navigating divorce and uncertain about how it will impact your taxes, it’s crucial to seek expert guidance tailored to your specific situation. Contact us today to schedule a consultation and ensure you’re making informed decisions every step of the way.

[1] TCJA citation