Divorce can upend your entire world — relationships change, you may need to move or sell your home, you’ll now be co-parenting your children. Taxes may be one of the last things on your mind, but it’s crucial to think pragmatically about how your divorce will affect your tax status. You don’t want an unwelcome surprise come next tax season.
Below are 10 potential tax implications of divorce to consider.
1. Timing matters.
For the year you get divorced, even if it is finalized on December 31, you must file as a single individual. If it’s financially advantageous to file as a married couple that year, discuss postponing the divorce finalization until the following January.
2. Filing together or separate?
When you do file taxes for your last full year as a married couple, you can still file a joint return to possibly get a better deal. However, if filing jointly takes more friendliness than you can muster with your ex, you can also file as “married filing separately,” which means you file and pay as if you were both single. This negates the benefits of jointly filing but could be easier if your relationship is strained.
3. Don’t let a tax increase blindside you.
Once you start filing as an individual again, you’ll lose the benefit of filing a joint return. This may increase your tax bill or minimize the return you’ve come to expect. Prepare by putting some extra money into savings this year.
4. Update your W-4.
If your withholding shows that were married even after your divorce, you could end up owing come April 15 or getting a lower-than-expected return. As soon as your divorce is final, ask your employer to assist you in updating your W-4 to reflect your new status.
5. Your tax bracket may change.
As you begin filing individually, you may find yourself in a different tax bracket — higher if you make more than your ex or lower if you make less. This can affect what you owe and your potential returns.
6. Custody matters.
It matters a lot. If you and your ex-spouse have been filing jointly, you’ve been able to both claim your children as dependents and take advantage of several tax credits. Once you determine who will have majority custody (more than 51%), that spouse will have the right to claim your children as dependents and “Head of Household” status, which can bring more tax benefits. This is a tricky area with many details, so be sure to consider these issues as you talk to your mediator and accountant.
7. Alimony and child support don’t really matter (tax-wise).
In years past, the spouse paying alimony could claim it as a tax credit and the person receiving it had to declare the money as taxable income. However, laws changed and this is only true of divorces that were finalized prior to January 1, 2019.
8. Pay attention to property transfers.
There is no tax on transfers that occur because of a divorce. However, if you decide to sell something you received in the divorce at a later time — say, stocks or rental properties that increased in value — you will need to pay capital gains tax on all the appreciation of that asset, from before the divorce and after. This is why it’s important to look ahead several years as you create your divorce mediation agreement.
9. Houses are even more complicated.
The rules are similar to property transfers. However, typically you can avoid tax on the first $250,000 of the appreciated value if it’s your primary home and you’ve lived there two years of the last five. Married couples can avoid taxes on $500,000 as long as one of you owned the residence and both of you lived there primarily for two of the last five years. These rules do shift post-divorce, so do your research and speak to a tax professional before selling property.
10. Dealing with retirement funds.
If you wish to provide retirement funds to your spouse, don’t just cash out your IRA or 401(k). Cashing out is considered taxable distribution and you could be on the hook for a hefty tax bill. Look into a Qualified Domestic Relations Order (QRDO), which can help you avoid big bills. Discuss this issue with your divorce mediator to ensure you follow all the rules.
The best advice we have is to consult with a tax professional well-qualified in divorce issues. While a divorce mediator can help you negotiate a divorce mediation agreement that will cover issues both today and for years to come, your mediator will be the first person to advise you to see a tax attorney or accountant when the need arises. This area of law is complex and you want to make sure you aren’t hit with avoidable taxes and fees. If you have complicated situations like property sales and asset transfers, ask your mediator for a referral to a tax professional.
Contact South Bay Mediation to set up a time to ask any questions you have about the tax implications of divorce and the process of divorce mediation.