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Understanding the Tax Implications of Divorce

Angelica Rolong Cormier | February 22, 2023

Divorce is often one of the most chaotic and emotionally challenging times in one’s life. With all the meetings to attend and disputes to settle, it’s understandable that taxes may not be a high priority for you at this time. However, it’s important to give considerable thought to the tax implications of your divorce settlement.

The reason for this is that divorce and taxes are intrinsically linked. How and when your divorce unfolds can have significant tax implications that may impact your finances for years to come. If you’re going through a divorce, there are several tax repercussions you should be aware of moving forward, during negotiation settlements and when preparing for tax filing.

1. Timing and Filing

If your divorce has not been finalized by the last day of the taxable year (December 31st) you and your spouse will still legally be considered married by state law. Should this be the case for you, you and your former spouse will need to determine how you want to file.

The two main options in this situation are “married filing jointly” or “married filing separately.”

Many of those dealing with a divorce and taxes at the same time choose to file jointly because it generally has the largest return and smallest liability. However, those considering this option should be aware that filing jointly makes both parties equally liable for any fraudulent or inaccurate claims made on the report. If your ex-spouse inaccurately reports data or there are gaps in the data reported to the IRS, you could incur penalties due to their mistakes.

Filing separately allows each spouse to be responsible for their own taxes. Reporting only your income, exemptions, deductions and credits may result in a lower return/higher liability, but you also avoid problems that may arise from trusting a spouse to file on your behalf. It is important for you to speak with an accountant or tax attorney before filing to discuss your options.

2. Dependent Claims

If you and your spouse have children, it’s important for you to understand that each child can only be claimed by one of you each year. IRS rules generally stipulate that the parent who has custody of the child/children for the majority of the year can claim the Child Tax Credit, but this isn’t always the case. According to the IRS, if the parents don’t file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher AGI for the year. If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.[1]

If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person’s AGI is higher than the highest AGI of any of the child’s parents who can claim the child.

Parents of a single child will sometimes alternate who claims the dependent each year, and parents with multiple children will often split up the claims between them.

[1] Qualifying Child of More Than One Person, Internal Revenue Service, https://www.irs.gov/publications/p501#en_US_2022_publink1000220917

3. The Transfer of Property/Assets

The transfer of assets during a divorce is usually treated as a non-taxable event. However, certain situations such as the selling of assets awarded through divorce may result in tax consequences. This is most commonly the case for spouses who shared high-value assets or owned a business. If this is the case for your divorce, it’s prudent to have an accountant or tax attorney review your settlement before you sign.

4. The Transfer of Retirement Assets

Retirement accounts can be incredibly high-value assets and most divorce settlements include terms as to how those accounts should be divided. Generally, withdrawing funds from retirement accounts results in large tax penalties, but this isn’t the case with divorce. Per the Employee Retirement Income Security Act (ERISA), retirement funds can be withdrawn from an account for transfer to a non-employee spouse without penalty, as long as it’s specified by a qualified domestic relations order (QDRO) issued by a court.

To avoid unnecessary tax penalties, it’s best practice to send a draft of the QDRO to the retirement plan administrator so that they can verify that it has met the required specifications.

5. Alimony Payments

Per the Tax Cuts and Jobs Act of 2017, any alimony payments made as part of divorce agreements finalized after January 1, 2019, are not considered taxable income for the spouse receiving the payments or deductible for the spouse making the payments. Spouses who made divorce agreements regarding alimony prior to this date can still claim the deduction.

6. Child Support

Child support payments are not considered taxable for the spouse receiving the payments or deductible for the spouse making the payments.

About the Author

Angelica’s clients include millennials, professionals, and their spouses, who value a constructive and intelligent approach to family law. She advises clients on a wide range of family law matters, including helping them to establish a solid financial footing and take care of their children. Her work often involves complicated custody, property, and financial matters. Angelica was named a 2022 “Texas Rising Stars” by Thomson Reuters and a 2023 “Ones to Watch” by Best Lawyers in America© in Family Law. She speaks fluent Spanish and is proficient in Portuguese.

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