Nobody likes a surprise letter from the Internal Revenue Service saying he or she owes more taxes. When your divorce is over, you want to be sure that you don’t later discover you owe taxes you weren’t expecting to pay.
Taxes are an important consideration in both settlement negotiations and trial preparation. They should not be overlooked. Taxes can impact many of your decisions, including those regarding spousal support, equitable distribution, and the receipt of benefits.
The following information is for general educational purposes only. It seems that every IRS rule has numerous, sometimes complicated, exceptions. Do not consider the following to be legal advice. Be sure to obtain tax advice from your divorce attorney, a tax attorney, or a certified public accountant (CPA).
13.1 Will Either My Spouse or I Have to Pay Income or Capital Gains Tax When We Transfer Property or Pay a Property Settlement to One Another According to Our Divorce Decree?
No. The allocation of assets and debts between spouses as part of a divorce is not taxable. Likewise, the payment from one spouse to another as part of the resolution of the divorce property issues is not taxable. However, it is important that you recognize the future tax consequences of a subsequent withdrawal, sale, or transfer of assets you receive in your divorce. It is important to ask your attorney to take tax consequences into consideration when looking at the division of your assets.
13.2 Is the Amount of Child Support I Pay Tax Deductible?
13.3 Do I Have to Pay Income Tax on Any Child Support I Receive?
13.4 Is the Amount of Spousal Support I am Ordered to Pay Tax Deductible?
13.5 Do I Have to Pay Tax on the Spousal Support I Receive?
13.6 What Is Our Tax Filing Status During the Divorce Proceedings?
You are considered unmarried if your decree is final by December 31 of the tax year. If you are considered unmarried, your filing status is either “single” or, under certain circumstances, “head of household.”
If your decree is not final as of December 31, your filing status is either “married filing a joint return” or “married filing a separate return,” unless you meet the requirements for filing as “head of household.”
While your divorce is in progress, talk to both your tax advisor and your attorney about your filing status. It may be beneficial to figure your tax on both a joint return and a separate return to see which gives you the lower tax. IRS Publication 504, Divorced or Separated Individuals, provides more detail on tax issues while you are going through a divorce.
13.7 Should I File a Joint Income Tax Return With My Spouse While Our Divorce Is Pending?
Consult your tax advisor to determine the risks and benefits of filing a joint return with your spouse. Compare this with the consequences of filing your tax return separately. Often the overall tax liability will be less with the filing of a joint return, but other factors are important to consider.
When deciding whether to file a joint return with your spouse, consider any concerns you have about the accuracy and truthfulness of the information on the tax return. If you have any doubts, consult both your attorney and your tax advisor before agreeing to sign a joint tax return with your spouse. Prior to filing a return with your spouse, try to reach agreement about how any tax owed or refund expected will be shared, and ask your lawyer to assist you in getting this in writing.
13.8 My Spouse Will Not Cooperate in Providing the Necessary Documents to Prepare or File Our Taxes Jointly. What Options Do I Have?
You will have to file married filing separately unless you meet the requirements for filing as head of household.
13.9 For Tax Purposes, Is One Time of Year Better Than Another to Divorce?
It depends upon your tax situation. If you and your spouse agree that it would be beneficial to file joint tax returns, you may wish to not have your divorce finalized before the end of the year.
Your marital status for filing income taxes is determined by your status on December 31. If you both want to preserve your right to file a joint return, your decree should not be entered before December 31 of that year. If you do not want to file a joint return, a divorce on or before December 31 would likely be best.
13.10 What Tax Consequences Should I Consider Regarding the Sale of Our Home?
When your home is sold, whether during your divorce or after, the sale may be subject to a capital gains tax. If your home was your primary residence and you lived in the home for two of the preceding five years, you may be eligible to exclude up to $250,000 of the capital gain on the sale of your home. If both you and your spouse meet the ownership and residence tests, you may be eligible to exclude up to $500,000 of the gain.
If you anticipate the gain on the sale of your residence to be over $250,000, talk with your attorney early in the divorce process about a plan to minimize the tax liability. For more information, see IRS Publication 523, Selling Your Home, or visit the IRS website at www.irs.gov, and talk with your tax advisor.
13.11 How Might Capital Gains Tax Be a Problem for Me Years After the Divorce?
Future capital gains tax on the sale of property should be discussed with your attorney during the negotiation and trial preparation stages of your case. This is especially important if the sale of the property is imminent. Failure to do so may result in an unfair outcome. For example, suppose you agree that your spouse will be awarded the proceeds from the sale of your home expected to net $200,000 after the real estate commission, and you will take the stock portfolio also valued at $200,000.
Suppose that after the divorce, you decide to sell the stock. It is still valued at $200,000, but you learn that its original price was $120,000 and that you must pay capital gains tax on the $80,000 of gain leaving you with a net amount of less than $200,00.
Meanwhile, your former spouse sells the marital home but pays no capital gains tax because he qualifies for the $250,000 exemption. He is left with the full $200,000. Tax implications of your property division should always be discussed with your attorney, with support from your tax advisor as needed.
13.12 During and After the Divorce, Who Gets to Claim the Child as a Dependent?
Under federal law, the parent who has custody of the child for more than one half of the year may claim the child as a dependent on his or her income tax return. However, the judge has authority, or the parties may agree, to allocate the dependency exemptions between the parties. If a dependency exemption is allocated to the noncustodial parent, the custodial parent will have to sign IRS Form 8332.
13.13 Do I Have to Pay Taxes on the Portion of My Spouse’s 401(K) That Was Awarded to Me in the Divorce?
No. If the transfer of retirement benefits is from your spouse’s retirement account directly to a retirement account in your name (usually an IRA), there are no taxes due from either party.
13.14 Is the Cost of Getting a Divorce, Including My Attorney Fees, Tax Deductible Under Any Circumstances?
Your legal fees for getting a divorce are not deductible. However, a portion of your attorney fees may be deductible if they are for:
- The collection of sums included in your gross income, such as alimony or interest income
- Advice regarding the determination of taxes or tax due
You may also be able to deduct fees you pay to appraisers or accountants who help. Talk to your tax advisor about whether any portion of your attorney fees or other expenses from your divorce are deductible.
Since the standard deduction was increased in 2018, fewer taxpayers now choose to itemize their deductions.
13.15 Do I Have to Complete a New Form W-4 for My Employer Because of My Divorce?
Completing a new Form W-4, Employee’s Withholding Certificate, will help you to claim the proper withholding allowances based upon your marital status and exemptions. If you are receiving spousal support, you may need to make quarterly estimated tax payments. Consult with your tax advisor to obtain tax planning advice.
13.16 What Is Innocent Spouse Relief and How Can It Help Me?
Innocent spouse relief refers to a method of obtaining relief from the Internal Revenue Service for taxes owed as a result of a joint income tax return filed during your marriage. Numerous factors affect your eligibility for innocent spouse tax relief. See IRS Publication 971, Innocent Spouse Relief, for more information.
Talk with your attorney or your tax advisor if you are concerned about liability for taxes arising from joint tax returns filed during the marriage. You may benefit from a referral to an attorney who specializes in tax law.