The Impact of Divorce on your Taxes

The Impact of Divorce on Your Taxes

Divorce can wreak havoc on your finances. What many divorced (or divorcing) couples don’t always realize is that they can expect to face recurring financial challenges during tax season for years after the divorce is finalized. While divorce is often (unfortunately) adversarial, leaving both spouses with animosity in its wake; tax season is an opportune time to put aside those differences and cooperate to reach a mutually beneficial outcome.

Filing taxes in the midst of and even after divorce can be complicated. Even after a divorce, many couples retain financial ties in the form of ongoing support, shared assets, lingering retirement plan divisions, and tax breaks; all of which can significantly affect tax liability. You can avoid another bitter battle by sitting down with your ex-spouse—and ideally a trusted lawyer—to discuss a few key issues.

Will You File Jointly or Individually?

Couples in the midst of a divorce can file “married filing jointly” or “married filing separately.” Each filing status has its pros and cons, so you should only make this decision after consulting with a lawyer and a tax advisor. Keep in mind that couples electing to each file their own taxes (individually) can later amend their return to file jointly. BUT, the reverse is not true – a couple cannot later amend their jointly filed return to make two individual returns.

Couples with a divorce finalized before the New Year have to file separately, so consider delaying the finalization of your divorce until after December 31st if you’d like to reap the benefits of filing as a married couple.

Whatever you do, don’t wait until tax season to decide how to file, and don’t decide without consulting with your spouse. Coordinating your filing status can be advantageous to both parties if you plan ahead. 

Uncle Sam always has the last word

The Tax Cuts & Jobs Act (TCJA) made significant changes to exemptions, deductions, and credits for your family’s federal income taxes. However, one major change that you might not have noticed is the way the law altered the potential tax consequences of divorce.

Unlike child support, alimony payments have long been tax-deductible for the ex-spouse making the payments and taxed as income for the recipient. And alimony payments were an above-the-line deduction, meaning that the payor did not need to itemize in order to benefit from the tax advantage.

Because the spouse making these payments was typically in a higher tax bracket than the recipient, shifting the income to the recipient’s lower tax bracket could result in significant overall tax savings. Indeed, this tax savings was often an important factor when negotiating divorce settlements, and it often led to larger alimony payments.

There could be situations where voluntarily modifying divorce agreements put in place before 2019 to apply the new tax treatment would benefit both parties. An example might be if the recipient spouse is now in a higher tax bracket than the payer-spouse. However, it’s best to consult with a lawyer to determine if such modification makes sense for your specific situation. 

Unlike many other new provisions of the TCJA, which will sunset in 2025, the repeal of the alimony deduction is permanent. It will remain in effect unless Congress makes future changes to the tax code. Consult with us to determine if such modification makes sense for your particular situation hello@yolofskylaw.com or schedule an intro call.

Who Claims the Children?

This is another important issue worth determining before tax season. Typically, the divorce judgment will include a stipulation on who gets to claim the children and the associated credits or deductions. Many couples choose to take turns by alternating years or each claiming one (or more) child individually. But if you don’t already have this determined in a court order, you might need help determining which parent has the most to gain one way or the other. In general, primary custodial parents have the right to claim the children, however, in the case of shared custody, that right can fall in either direction. Likewise, divorcing couples that are filing separately will need to make this decision, but it is best first to figure out whom the claim will benefit the most before you decide. The IRS updated its software to track if a particular child has already been claimed by a parent. 

Dividing More Than Just Your Home

Not all types of property divisions are tax friendly. Make sure you consult with a lawyer before you put your property division in writing to ensure the spouse who receives the assets is not met with an undue tax burden come tax season. This is more of a concern for couples in the midst of a divorce, but divorced couples can run into issues about jointly held assets (such as the family home), too. And failing to include a stipulation regarding jointly owned assets in the judgment can create trouble.

The spouse who retains residence of the family home doesn’t necessarily get to claim all the tax benefits, especially if he or she is not financially responsible for the home. Cooperation is essential in this circumstance. The division of retirement accounts can also affect your taxes. Make sure you file a Qualified Domestic Relations Order to divide plans without penalty. Liquidating the accounts to divide them will result in penalties and a higher tax liability.

How Will You Characterize Support?

Orders for alimony (also called spousal support or spousal maintenance) and child support are common in many divorces. Child support has no bearing on tax liability and cannot be deducted. Alimony, however, is a little more flexible. Alimony is typically taxed as income to the receiving spouse and a deduction for the paying spouse, but the wording in your judgment can affect this. Work with a lawyer before you finalize your divorce to ensure your alimony order will be mutually beneficial to you and your spouse.

If you’re divorced and need financial guidance, don’t feel like you are alone. We can help you strategize your tax filing for maximum benefit this tax season call us at (954) 237-4011 or email us at hello@yolofskylaw.com