There are common tax issues that arise during a divorce. However, during such an emotional time, working through those tax issues could be the furthest thing from someone’s mind. Divorce attorneys are there to help with the physical separation of assets and to handle custody and support arrangements, but the tax implications of the agreements may not be forefront in their minds. As tax professionals, we find that it is advantageous to work proactively with clients and their attorneys to address the tax issues that arise from divorce. They range from filing status and dependency exemptions to alimony, child support, and property settlements. Failure to recognize an issue and address it in the divorce settlement may result in long-term consequences that could have been avoided.
The following items are several issues that commonly need to be addressed when considering the tax implications of a divorce:
- Filing status during year of separation – Prior to the finalization of the divorce, taxpayers have several options for filing status. They can file ‘Married Filing Jointly,’ ‘Married Filing Separately,’ and in certain circumstances, one or both spouses can file ‘Head of Household.’ Each filing status has different tax brackets and rules that affect overall tax liability.
- Dependency exemptions – If the divorcing spouses have dependent children, determining who can or should claim the children will impact the tax calculations. This decision can also impact eligibility for child tax credits, dependent care credits, and education credits.
- Property settlements – Payments for property interests and transfers of property pursuant to a divorce generally are not taxable to the receiving spouse nor deductible by the paying spouse, but there are tax basis and other potential tax issues that require special attention in marital dissolutions. Topics commonly requiring special planning emphasis include transferring the marital residence and structuring the transfer of one spouse’s stock in a closely held business.
- Support payments – These payments represent either alimony and are intended to provide support for the lower earning spouse or child support. Under prior tax law (which will apply through 2018), alimony is a payment which is taxable to the receiving spouse and deductible by the paying spouse. Under the Tax Cuts and Jobs Act of 2017, effective for divorce or separation instruments executed after 2018, the New Law repeals the deduction for alimony payments, and the alimony payments will no longer be taxable to the recipient. If the divorce instrument is executed before 2019, but modified after 2018, the alimony payments made after the modification will continue to be deductible by the individual making the payments (and taxable to the recipient) unless the modification expressly provides that the alimony payments are to be nondeductible to the payer and taxable to the recipient.
The above list is not exhaustive. There are many other situations that arise in a divorce that need special consideration for tax implications, including splitting retirement accounts and potential distributions, the deductibility of legal fees or tax advice, and the requirements to maintain health insurance coverage. If you are working through separation agreements or have questions about the tax ramifications of divorce, please contact us.