Tax Implications of Divorce

Divorce brings financial challenges, and understanding the tax implications is crucial for a smooth transition. By considering factors such as filing status changes, alimony, property division, and retirement, you can navigate the complexities and make informed decisions that set the foundation for a stable financial future post-divorce.

Here’s a quick summary of the most important divorce tax implications to keep in mind moving forward:

The first and most obvious implication is your post-divorce tax filing status, which can depend on when in the year you legally separated. You can use the official IRS “what is my filing status” tool, or follow their basic guidelines, summarized here:

• If you’re separated, but not legally separated on the last day of the year, you should still fill out your 1040 as “married” (likely “married, filing separately” if you and your ex want to file separate returns).
• If you’re legally separated at the end of the year, you must file separate, single tax returns.

Also, you can only be considered “head of household,” according to the IRS, if your spouse didn’t live with you for six months last year, if you paid more than half the cost of maintaining the house, and your home was the main place for your dependent for more than six months last year.

Typically, divorce and tax filing for dependents can depend a great deal on the legal proceedings of your case, but most often the person who lives with the dependent the majority of the time is considered the primary custodian, and will claim the child in question as a dependent. Claiming dependents can only be done by one divorced parent at a time, but sometimes tie-breaker rules can be applied or the non-custodial parent can claim the dependent if the custodial parent fills out form 8332.  

• You may qualify for dependent-related credits as the primary custodian, such as the child tax credit or other education credits.
• Note that you may still qualify for the medical and dental expense deduction if you are paying for the child’s medical bills, regardless of custody.

Are divorce attorney fees tax deductible? Unfortunately, they are not. These are considered personal expenses.

A simple thing to forget but also very important – update your W-4 with your employer to claim your updated filing status to ensure proper withholding.

Since the 2017 Tax Cuts and Jobs Act, alimony payments for divorce agreements made after 2018 are no longer tax deductible for the payor. Also, the payee does not need to declare alimony payments as taxable income. (For years before 2018, alimony taxes were opposite, with a tax deduction available for the payor and the payee needing to declare the income.)

Child support is not deductible by the payor, nor is it considered income by the payee.

Typically, the transfer of property from a married couple to one former spouse does not lead to a recognized gain or loss, though sometimes individuals will need to report the transaction as a gift. This “tax-free transfer” rule typically applies within a year after the date of the divorce.

On the other hand, it’s very common for divorced couples to sell a home in the months-long process of divorce, and in that situation, it may lead to a capital gains tax implication. You can exclude a maximum $250,000 gain on a property where you’ve used as a primary home for at least two of the last five years.

Simply put, if property is transferred to you during the divorce agreement and you later sell it, you will likely pay taxes in capital gains and all the appreciation before and after that transfer.

All of this can get more complicated with second homes or rental homes, so it’s best to talk to an accountant as well as a lawyer during the divorce process.

Retirement assets can be a huge, thorny issue during divorce because it represents large amounts. For most, divorcees will want to avoid withdrawal fees and issues with the use of a Qualified Domestic Relations Order (QDRO) that complies with the Employee Retirement Income Security Act (ERISA). It’s generally recommended that this document be reviewed by an administrator. For IRAs, this will need a transfer incident to divorce.

Also, it’s of note that if you’re not paying taxes on your earned alimony, you cannot apply it to a Roth IRA or IRA.

While a lawyer might want to negotiate a divorce tax refund split during the proceedings, things can get messy when the IRS is owed taxes. In those cases, both spouses are liable to the IRS. Most states demand an equal division of tax debt, with the exception of some states, which distinguish between debts acquired before or during the marriage.

If one spouse does not comply and pay back taxes, the IRS tax collector will still seek back taxes from the other spouse; legal proceedings, therefore, sometimes may result.

Do you still have important divorce tax questions specific to your circumstances? Consider reviewing IRS Publication 504 or getting in contact with an experienced CPA to get your urgent questions answered.

About Tabitha Regan

Tabitha Regan is the Founder and CEO of LittleOwl CPA. She is a Certified Public Accountant, Certified Financial Planner™ and Personal Financial Specialist. In her 16+ year career span, she has developed an expertise in the specific needs of small businesses and busy professionals with accounting, tax and advisory services.