8 Things to Know About Divorce and Taxes
Every marriage starts with a sense of hope and the expectation that things will be indefinitely blissful and romantic. But the cold, harsh realities of life have a knack for getting in the way. And when they do, the friction can prove to be too much.
Excessive and prolonged friction often leads to divorce, which reveals an entirely new set of challenges to deal with – including taxes.
If you’re filing for divorce, or find yourself recently divorced, it’s imperative that you understand how your changing marital status impacts your tax return.
Let’s explore some of the important things you need to know about divorce and taxes:
- Get Clear on Your Marital Status
Your marital status isn’t as simple as you may think. It is, however, vital that you get clear on how the IRS views you. After all, it’ll have a pretty significant impact on your filing status.
By IRS rules, your status on December 31 is your status for the entire tax year. In other words, if your divorce was not yet final as of December 31, 2019, you’re technically still married for the 2019 tax year. Likewise, if you were married for 364 days of 2019 and the court issued your divorce on New Year’s Eve, the IRS considers you unmarried for the whole year.
It doesn’t matter if you and your spouse are legally separated, or if you’ve been living apart for years, the IRS is clear on its rules.
2. You’ll Need to Choose a New Filing Status
If you’re no longer married, you can no longer file with a status of “married filing jointly” or “married filing separately.” You now have to choose between two separate options: either “single” or “head of household.”
Filing single is pretty self-explanatory. The head of household designation is a little more complicated, but can provide some noteworthy benefits to those who qualify. (This includes a higher standard deduction, lower tax rate, and eligibility for certain tax credits.)
You can only file as head of household if (a) you’re not considered married as of the December 31 deadline of the year in which you’re filing your tax return; (b) you paid at least half the cost of home upkeep during the year; and (c) a “qualifying person” lived with you for at least half the year (or meets other very specific requirements).
Here’s the trick: After a divorce, only you or your ex-spouse can file as head of household. You can’t both claim this status. If you both share equal custody of children, the person with the higher adjusted gross income can typically claim the children for tax purposes.
3. Can You Deduct the Legal Costs of Your Divorce?
The simple answer is no.
The more complicated answer is that, while you could never deduct fees and expenses associated with divorce filings (nor court costs), there was a time when you could deduct the fees associated with generating income – like hiring a lawyer to help you secure an alimony order. However, the recent changes to the tax code eliminated this “miscellaneous itemized deduction.” Currently, there are no deductions or credits associated with legal expenses in a divorce.
4. Recent Changes to Alimony and Child Support
The IRS does not allow you to deduct child support that you pay to an ex-spouse. The logic is that if you and your ex had stayed married, you wouldn’t have been able to claim a tax deduction on basic household expenses like food and clothing for the kids. These are viewed as personal expenses, regardless of whether you’re married or divorced.
Alimony used to be different until the Tax Cuts and Job Acts of 2017 (TCJA). It used to be that the person paying alimony could claim a deduction, while the spouse receiving alimony had to claim it as income on their return. But as of 2019, alimony is no longer tax deductible, nor is it viewed as income. However – and this is very important – divorces in which alimony was established prior to January 1, 2019 are grandfathered into the system. This means payments remain tax deductible.
5. Tax Implications of Selling a Home
If you owned a house in marriage, there’s a chance you’ve sold (or will sell) the house after the divorce. And if it’s sold at a profit, there could be tax implications.
If you and your spouse owned the house and used it as your primary residence for at least two of the five years prior to selling, you could exclude up to $500,000 in gains on the sale of the house (if you’re still legally married and filing a joint return).
If, however, you and your ex-spouse are already divorced, you can each exclude up to $250,000 in gains. (If just one person ends up owning the house as a single filer, that person can still only exclude up to $250,000.)
6. Be Smart When Splitting Assets
Not all assets are viewed equally in the eyes of the IRS. If you and your spouse have considerable assets, be mindful of how you split them up.
For example, the IRS doesn’t view $200,000 of cash in a divorce settlement the same way it looks upon $200,000 in stocks and bonds. The cash is transferred tax-free. The stocks and bonds, however, can be exposed to capital gains taxes when sold.
It’s also important to consider the history of a stock portfolio. A $200,000 portfolio with an original investment of $50,000 will be taxed significantly more than the same stock portfolio with a $125,000 basis.
The key is to check and double-check everything so that you don’t get hit with a major tax surprise down the road.
7. Divvying Up Retirement Benefits
If you and your ex-spouse have shared retirement plans, your divorce will stipulate how these assets are handled. In turn, this will affect your taxable income.
It’s important to be strategic in how you share retirement assets. While it’s possible for one spouse to agree to give retirement payouts to the other, this can incur major tax implications. The IRS sees this as a taxable distribution and will treat it as such. Fees, penalties, and taxes will be incurred.
The better option is to wait until after retirement. In the meantime, the court can serve a Qualified Domestic Relations Order – known as a QDRO. This instructs the pension plan provider or retirement plan holder to pay a certain portion of the plan to an alternate payee (the ex-spouse).
8. Hire a Tax Professional
Divorce and taxes – they aren’t necessarily a match made in heaven. If you’re going through a divorce, or recently finalized one, it’s more important than ever that you hire a seasoned tax professional to help you work through these nuances. Not only will it save you money, but it’ll provide you significant peace of mind.
Taxfyle: Your Helping Hand
Divorce and taxes can be a sticky subject. But at Taxfyle, we’re here to put your mind at ease. Whether you’re an individual or a small business, we’d be happy to connect you with a licensed CPA professional to file your taxes this year.
Taxfyle is a one-stop online tax service that takes the hassle, confusion, and unpredictability out of finding the right professional to do your return. We have a robust network of U.S. based CPAs and EAs who possess a thorough understanding of how to handle divorce and taxes, as well as dozens of other complicated circumstances. Get started today!
