Divorce and Taxes
Understand the tax implications of divorce. From filing status changes and alimony taxation to property transfers and claiming dependents, this guide helps you avoid costly tax mistakes during and after divorce.
What You'll Learn
- Understand how divorce affects your tax filing status
- Know the current tax treatment of alimony and child support
- Learn the tax implications of dividing property and retirement accounts
- Avoid common tax mistakes during and after divorce
1. Filing Status Changes
Your marital status as of December 31 determines your filing status for the entire year. If your divorce is finalized by December 31, you file as single or, if you have a qualifying dependent child, as head of household. If still legally married on December 31, you can file as married filing jointly or married filing separately. Head of household status provides a higher standard deduction and more favorable tax brackets than single filing status.
Key Points
- Your filing status is determined by your marital status on December 31 of the tax year
- Head of household status offers better tax rates than single status for custodial parents
- Married filing separately usually results in higher combined taxes but separates liability
- Filing jointly during divorce can save money but creates joint tax liability
2. Alimony and Child Support Tax Treatment
Under the Tax Cuts and Jobs Act of 2017, the tax treatment of alimony changed significantly for agreements executed after December 31, 2018. For post-2018 agreements, alimony is not deductible by the payer and not taxable to the recipient. For agreements executed before 2019, the old rules still apply: alimony is deductible by the payer and taxable to the recipient. Child support has never been tax-deductible or taxable regardless of when the agreement was made.
Key Points
- Alimony under post-2018 agreements is not deductible by the payer and not taxable to the recipient
- Pre-2019 alimony agreements retain the old tax treatment unless a modification expressly adopts the new rules
- Child support is never tax-deductible and never taxable income
- The tax change significantly affects alimony negotiation strategies
3. Property Transfers and Capital Gains
Property transfers between spouses as part of a divorce settlement are generally tax-free under IRC Section 1041. However, the recipient takes the transferring spouse's tax basis in the property. This means capital gains taxes may be owed later when the property is sold. For example, receiving a home with a low basis means potentially large capital gains taxes upon sale. Understanding basis is critical when comparing the true after-tax value of different assets in settlement negotiations.
Key Points
- Property transfers between spouses incident to divorce are not taxable events
- The recipient inherits the transferring spouse's cost basis in the property
- Future capital gains taxes should be considered when valuing assets in settlement negotiations
- The primary residence exclusion ($250,000 for single filers) may apply to home sales after divorce
4. Retirement Accounts and Dependent Claims
Distributions paid to an ex-spouse from an employer plan under a QDRO are exempt from the 10% early withdrawal penalty, but they are taxed as ordinary income, and the exemption does not carry over once the money is rolled into an IRA. The custodial parent generally claims the children as dependents, but the custodial parent can release the claim to the other parent with IRS Form 8332, for example in alternating years. Only one parent can claim head of household status based on a particular child.
Key Points
- QDRO transfers are not subject to the 10 percent early withdrawal penalty
- Distributions from transferred retirement accounts are taxed as ordinary income when withdrawn
- Parents can agree to alternate which parent claims the child as a dependent
- IRS Form 8332 allows the custodial parent to release the dependency claim to the other parent
5. Common Tax Mistakes to Avoid
Divorcing couples frequently make costly tax errors. Common mistakes include not considering the tax implications when comparing asset values, failing to update withholdings after divorce, forgetting to attach Form 8332 to the return of the parent claiming the child each year, not understanding that joint tax returns create joint liability, and failing to address taxes owed for prior joint returns in the divorce agreement. Working with a tax professional who understands divorce is strongly recommended.
Key Points
- Compare assets on an after-tax basis, not just face value
- Update your W-4 withholdings promptly after divorce
- Address liability for prior joint tax returns in your divorce agreement
- Consider requesting innocent spouse relief if your ex underreported income on joint returns
Key Takeaways
- Property transfers between spouses as part of divorce are tax-free under IRC Section 1041, but the recipient takes the transferor's basis.
- The Tax Cuts and Jobs Act eliminated the alimony deduction for agreements executed after December 31, 2018.
- Only the custodial parent (the parent with whom the child lived for the greater number of nights) can claim head of household status based on that child.
- IRS Form 8332 allows the custodial parent to release the dependency exemption to the non-custodial parent.
- Innocent spouse relief (IRS Form 8857) can protect you from tax liability caused by your ex-spouse's errors or fraud on joint returns.
- The cost of divorce-related tax advice is tax-deductible as it relates to income production, but general legal fees for divorce are not deductible.
Common Questions
1. How did the Tax Cuts and Jobs Act change the taxation of alimony?
2. What is the tax impact of receiving the family home in a divorce settlement?
3. Who gets to claim the children as dependents after divorce?
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FAQs
Common questions about this topic
Divorce legal fees and court costs are not tax-deductible, and IRS Publication 504 says the same for fees paid for tax advice connected with the divorce and fees paid to get alimony.
Innocent spouse relief (IRS Form 8857) protects you from tax liability resulting from your spouse's errors, fraud, or omissions on joint tax returns. To qualify, you must show that you did not know and had no reason to know about the incorrect items, and that it would be unfair to hold you liable. This can be filed even years after the tax return was filed.