Taxes and the Divorce Process
For couples who are going through a divorce, the last thing they are usually thinking about is their taxes. The divorce process will have major implications on many areas of your finances, however, and there are numerous potential tax consequences that divorcing spouses should be aware of. These issues should be addressed well ahead of time. Otherwise, you may end up with some very unpleasant surprises at tax time.
Tax Filing Status
The first issue to consider with regards to taxes during a divorce is what filing status you will use. Your filing options are largely dependent on the timing of your divorce. If your divorce was finalized before December 31st of the tax year for which you are filing, the IRS considers you “unmarried” for the entire year. This means you will not have the option of choosing the status “married filing jointly” or “married filing separately”. You will need to either file as “single” or “head of household”, depending on your circumstances and what you qualify for.
Filing “head of household” gives you a larger standard deduction, potential access to some valuable tax credits, and usually lower tax rates. However, you are only allowed to file “head of household” if you paid for at least half of the upkeep of your home and you had a dependent living with you for at least half the year.
If your divorce was not finalized until after December 31st of the previous year and/or the divorce is still in process at the time you file your taxes, your status will either be “married filing jointly” or “married filing separately”. In general, “married filing jointly” provides better tax benefits for spouses, although this is not true in all cases.
Aside from the tax benefits, however, there are other reasons you may want to consider choosing “married filing separately”. In particular, if you have an uncooperative or untrustworthy spouse or you are concerned about a potential tax liability resulting from fraud or misrepresentations on the tax return, choosing “married filing separately” might be a better option. Another scenario where filing separately would likely be beneficial for you is if your taxes are withheld from your paycheck throughout the year but your spouse is self-employed and has not paid his or her quarterly tax obligations. Speak with your tax professional for additional guidance regarding your specific situation.
Who Gets to Claim the Children on their Taxes?
If you have children, there is the question of which parent will be able to claim them as dependents. Generally, the parent who has custody of the children for more than half of the taxable year is the one who receives the dependency exemption. However, the custodial parent may release their claim of exemption to the other parent by signing a written declaration on their tax return. This issue is sometimes negotiated during the divorce proceeding, although it is not as important an issue as it once was.
The Tax Cut and Jobs Act of 2017 did away with personal exemptions while raising the standard deduction. This means that claiming dependents is a moot point for now, until this provision expires in 2025. The dependency exemption may still be important for other reasons, however. For one thing, you cannot file “head of household” without a dependent. Dependents also make you eligible for a higher Earned Income Tax Credit, and you may also be eligible for a Child Tax Credit and/or Child and Dependent Care Credit if you have children to claim.
It is important to note that the non-custodial parent is not allowed to claim “head of household” if they did not have at least one dependent living with them for at least half of the year. So, even if the custodial parent releases their claim of exemption for the children, this still does not make the non-custodial parent eligible for this filing status.
Division and Dissolution of Assets during a Divorce
Dividing marital assets during a divorce is generally a tax-neutral event. That said, if you have significant assets and/or a more complicated financial structure (such as a family-owned business or unique investments), your divorce could produce adverse tax consequences. In such cases, it is best to consult with a tax professional to help determine how the division of such assets will impact your taxes, and the best way to minimize your tax liability. There may also be tax implications for the sale of certain assets, such as the sale of real estate wherein you may be responsible for capital gains taxes.
Division of Retirement Accounts
Many people believe that personal retirement accounts are not part of the marital estate. This may be true for the portion of the account that was accumulated prior to the marriage. However, assets within the account that were added or appreciated during the course of the marriage generally belong to both spouses. In order to withdraw retirement funds without penalty (to distribute to the other spouse), you will most likely need a qualified domestic relations order (QDRO). QDROs can be complicated documents that need to be drafted properly in order to meet all the required specifications. Consult your attorney to determine which type of QDRO you will need (depending on the type of retirement account you have) to avoid potential tax liability.
Child Support and Alimony
There are no tax consequences associated with the payment of child support. They are not deductible for the payor, and the payee does not have to claim these payments on their income taxes. Alimony/spousal support payments used to be deductible for the payor and taxable income for the payee. However, under the Tax Cut and Jobs Act of 2017, for all divorces finalized after December 31, 2018, alimony/spousal support payments are now tax-neutral.
Contact an Experienced Divorce and Family Law Attorney
If you are facing a divorce, it is important to work with an attorney with in-depth experience in this area of the law. Taxes and other complicated issues will arise during the divorce process. For this reason, you need a lawyer who understands how to effectively handle these issues and help ensure that you are in the best possible financial position once the divorce is finalized.
In South Carolina, contact the Cate Law Firm at 864-251-5855 for skilled legal guidance on divorce, asset division, QDROs, and all other family legal matters. You may also message us through our online contact form or stop by our Spartanburg office at your convenience.