Dealing with Divorce and Taxes

December 5, 2023

Divorce and taxes—two topics most people don’t wish to think about. However, tax issues have a substantial impact on divorce and the lives of those involved. Here are a few key divorce tax takeaways that are sometimes forgotten:

  1. Update Your Withholdings. People typically file a new form W-4 with an employer to change withholdings after their divorce is final to update your new tax status. Talk to your accountant about your specific needs and circumstances before doing so though.
  2. The Spousal Maintenance Tax Loophole is Closed—­Probably Forever. In the good old days, parties could use spousal maintenance as a way to “increase the pie” and have Uncle Sam pay for part of it. Spousal maintenance was taxable to the recipient and tax-deductible to the payor. This meant that the higher earning spouse could typically transfer funds to the lower earning spouse, thereby decreasing the overall tax paid. Sometimes, property settlements were disguised as spousal maintenance in order to provide further tax benefits. No more. For divorces after January 1, 2019, spousal maintenance is no longer taxable to the recipient and the payor pays the income tax. You can imagine how payors feel about this particular change in the law.
  3. Deal With Dependency Exemptions. Generally speaking, a parent who has 50% or more of the parenting time gets to claim the child tax dependency exemption. However, state law can modify that, and many divorcing parties stipulate an equal division of tax dependency exemptions. If the parties can’t agree, courts must apply several factors and make specific findings on who will claim a dependent child after the divorce is final.
  4. Divorce Property Division is Generally Not a Taxable Event. Some people, and even accountants, misunderstand the rule. Generally speaking, there is no recognized gain or loss on property transfers between spouses or former spouses if the transfer is because of a divorce. There is no specific timeframe on when the actual transfer has to occur. Therefore, a divorce that says Spouse A will pay Spouse B two million dollars over 20 years will allow the parties to do so without it being a taxable event even though the final payment will occur decades in the future. Assets divided go to the recipient spouse with the asset’s built-in tax attributes. So, a spouse awarded land with significant capital gains attached will pay all of those capital gains when the property is sold. That means if sale is imminent and necessary, it is a good idea to simply sell the property together and share the tax obligations if a sale is necessary or imminent.
  5. Filing Status Changes. Many people also forget that when parties divorce, they are considered single in the year they divorce. Even if you divorce on December 30, you are considered single for that entire tax year. However, if you have qualifying children, you may be able to claim head of household status and there are factors the IRS looks to for that. With multiple children, it is possible for both parents to claim head of household if each has a child for one day more than half the year, which is sometimes written into a divorce agreement.

Tax considerations can play an important role in a divorce, including timing and other issues. Although not sexy, resolving these issues the right way can greatly impact you tax-wise.

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