Five common tax issues in divorce
One of the many considerations individuals face when divorcing is how to deal with taxes. There are many tax ramifications of divorce. Understanding how to handle personal income taxes both before and after your divorce will help you avoid unexpected tax consequences or an audit.
Read on to understand more about how taxes may impact your divorce. The following are the answers to five common questions about taxes and divorce.
1. How should taxes be filed?
Until you are divorced, your taxes must be filed either married, filing jointly or married, filing separately. In limited circumstances, a party may also file head of household prior to divorce. Once you are divorced, the IRS and the State of Wisconsin consider you unmarried for the entire year of your divorce for purposes of determining how to file your taxes. If your divorce was finalized on December 31st, you will file as a single taxpayer or head of household for that year. Your former spouse will file separately.
2. Who gets to claim the kids?
The ability to claim children as dependents is something that should be handled with your attorney as part of the divorce and written into your divorce agreement. There are tax benefits to being able to claim head of household status with or without a dependent child as an exemption.
Typically, in Wisconsin, the parents share the exemption(s) as long as they both have placement of the children and are paying towards their support. Parents who have children living with them less than six months out of the year may claim a child as an exemption provided the court orders the same and they submit a Form 8332 signed by the former spouse with their tax returns. The head of household filing status is determined by the parent with the greater number of overnight each year. If there is an equal placement schedule, the parties can also agree that one parent can have one additional overnight per year in order to qualify for head of household status .
3. Is child support deductible/taxable?
Child support is neither deductible by the parent paying it nor taxable to the parent receiving it.
4. How are maintenance payments (also known as alimony) treated?
For divorce agreements created prior to January 1, 2019, maintenance payments are deductible by the payor (the person paying them) and taxable as income by the payee (the person receiving them).
However, the Tax Cuts & Jobs Act of 2017 changed how tax law addresses maintenance payments. In divorce agreements created on or after January 1, 2019, or those modified after that date, maintenance payments are not deductible by the payor or included in the payee’s income.
5. Are there tax consequences when dividing property in a divorce?
Assets divided in a divorce are generally not taxable, but certain assets must be transferred properly to avoid tax consequences. 401ks, pensions and some other types of retirement assets must be transferred via a special court order called a qualified domestic relations order, also known as a QDRO. A QDRO is drafted after the divorce is finalized and given to the retirement administrator to transfer the assets. An IRA can be divided without a QDRO but must be rolled over to another IRA in the receiving party’s name to avoid tax consequences. The person receiving the retirement account monies must invest those funds in some sort of qualified plan (such as an IRA) to avoid tax consequences.
If a property equalization payment in a divorce is received in cash, such as a payment for a house or bank account, that payment is not taxable or deductible. However, there still may be taxes owed on an asset received in a divorce, such as capital gains on stock or real estate, in the event of a future sale or liquidation. This may affect the value of the asset and it is important to have that knowledge when negotiating your final divorce agreement.
There are other tax issues that must be considered as part of a divorce as well. Whether you are separated, in the process of divorce or your divorce was recently finalized, make sure you talk with a tax preparer as well as an experienced family law attorney to ensure you understand the ramifications of divorce with your taxes.
Family law attorneys who are experienced in all issues related to divorce can assist you in avoiding any negative tax consequences in a divorce as well as maximizing your net income and assets.