Divorcing spouses face emotional challenges, but overlooking the tax consequences of divorce can be a costly mistake. Working with an experienced divorce attorney at Aiello & DiFalco LLP is the best way to make informed decisions and protect your interests. Let’s look at several tax consequences to consider during a divorce.
How Does Alimony/Spousal Maintenance Affect Taxes?
Under current federal tax law, the spouse paying alimony (spousal maintenance) cannot take a tax deduction on these payments. Moreover, the recipient is not required to report alimony payments to the IRS, and alimony is not considered taxable income. Notably, the paying spouse must report and pay taxes on all income, including alimony payments to a former spouse.
A capable divorce attorney can help to offset the tax consequences of paying alimony by negotiating an appropriate amount to be paid.
Does Child Support Count as Income for Taxes?
The IRS treats child support and alimony payments the same way. In short, child support payments are not tax-deductible for non-custodial parents and do not count as income for recipient parents. Unlike alimony, however, you cannot negotiate payment amounts to limit the tax consequences of paying child support, which is calculated based on New York’s child support guidelines.
Determining Deductions After a Divorce
Married couples can take several deductions and credits on their tax returns, including head of household status and credits for dependent children. Figuring out which spouse is entitled to claim these deductions after a divorce is challenging. Under IRS rules, a child must live with a parent for more than 6 months for that parent to qualify for head of household status, and the parent who has primary custody can claim tax credits for dependent children.
IRS rules in this regard are not set in stone, and the spouses may be able to negotiate dependent child credits and alternate exemption years to limit the tax consequences of divorce. However, if the noncustodial parent claims the exemption, the custodial parent must complete IRS tax forms releasing their claim.
Tax Consequences of Marital Property Distribution
Under IRS rules, transfers of property between spouses incident to a separation or divorce are not taxable as long as the transfer occurs:
- Within 1 year of the cessation of the marriage, or
- Not more than 6 years after the date of the cessation of the marriage if it is pursuant to a divorce or separation agreement.
The IRS considers transfers that occur outside these timelines taxable events.
Capital Gains Taxes on Property Sold After Divorce
The IRS permits a $250,000 per person or $500,000 per couple capital gains exclusion on profits from the sale of a residence. Therefore, if you receive the marital home as part of your divorce settlement and then sell it, you can only claim the $250,000 capital gains exclusion. If you and your spouse sell the home before the divorce, you are entitled to the $500,000 exclusion. An experienced divorce attorney can advise you about the tax consequences of dividing marital property and capital gains taxes.
Retirement assets are subject to equitable distribution, which can significantly impact your financial future. For certain retirement accounts, such as 401(k)s, a Qualified Domestic Relations Order (QDRO) must be created and accepted by the plan and the court for the asset to be distributed. In any event, retirement assets distributed in a divorce are not taxed, as long as they are rolled over into another retirement account.
Other Tax Considerations For Divorcing Couples
Another tax issue divorcing couples must determine is the appropriate filing status. A couple’s tax filing status is determined by their marital status on the last day of the tax year (December 31). If the divorce is not finalized by that date, they must determine whether to file a joint return or choose married filing separately.
While filing joint tax returns may result in lower tax liabilities for both spouses, it may be more advantageous for spouses with similar incomes to file as single or head of household. Also, if they file a joint return, each spouse is liable for any tax liability from the return. In any case, how you file your income tax return for the year of the divorce must be specified in your settlement.
Talk To An Experienced About The Tax Consequences of Divorce
These are just some of the tax implications of divorce. High-net-worth couples and marriages that involve closely held businesses involve additional tax consequences. Divorce is a difficult transition that may have significant tax consequences regardless of your financial status. Turn to Aiello & DiFalco LLP for the trustworthy advice you need and deserve.