Tax Implications of Your Divorce
How a Divorce May Affect Your Taxes
After a couple has decided to part ways, there are plenty of things to consider for the future. While taxes might not be a top priority for divorcing spouses, assets and liabilities can impact their tax situations for years to come.
Don’t Wait Until It’s Time to File
During a marriage, many couples share income and property. They also file their taxes together. With a divorce, all assets, income, and property will need to be divided between the couple. Some individuals will need to take a second look at their taxes and the potential ramifications of a divorce settlement.
Now that you are no longer married to your partner, you need to think about your tax situation. Many people forget about their taxes until it is time to file them, but that is a mistake. By that time, it could be too late to fix any issues, causing you to pay more in taxes. Here are a few significant tax implications of a divorce.
Think About Spousal Support
These payments are used in divorce settlements to move cash from one spouse to another. Keep in mind that these payments can impact an individual’s taxable income. Alimony is considered a type of spousal support. Separation or divorce agreements signed on or after Jan. 1, 2019, are governed under a tax law stating that alimony income is not taxable. Along with that, there is no tax deduction for the alimony paid out to the other spouse.
You might think that all payments are considered alimony, but that is not always the case. For the spousal support to be deemed alimony, the payment must be made according to the separation agreement or divorce decree. In addition to that, the spouse must make the payments in cash. Those payments cannot be in the form of property. There are other requirements, such as that the spouses cannot live in the same household, file a joint tax return, or require payments after the death of a spouse.
Assets Can Have Tax Ramifications
Those liabilities and assets granted in the divorce settlement can have significant tax ramifications. Assets are taxed differently. For example, IRA and 401(k) accounts are considered retirement assets. There is a difference between receiving money from a Roth IRA or a retirement plan asset. Traditional IRAs or retirement plan assets are considered taxable when those assets are distributed to beneficiaries. However, Roth IRAs and retirement plan assets can be distributed to the beneficiary as tax-free income.
In many divorces, real estate is part of the settlement. When that asset is sold, then that income could be considered taxable. For that reason, it is crucial to know the cost basis of the real estate property. With that information in hand, tax deductions can be claimed on the real estate, such as the amount of depreciation. Both depreciation and cost basis will make a difference in the taxable income when the real estate is sold. Consider the potential tax and distribution of assets when dividing them in a divorce settlement.
Changes to Tax Filing Status
After a separation or divorce, there will be a change to the couple’s tax filing status. These statuses determine many factors on the tax return, including the tax rate. The taxpayer’s marital status on the last day of the year will determine that filing status.
If the divorce is finalized on or before December 31, the individual would be considered divorced for the whole year. Divorced taxpayers will be able to use the “head of household” or “single” filing status for the tax year that the divorce was finalized.
Remember that a divorce can be a long and complicated process. In some cases, the couple could still be married at the end of the tax year. Those taxpayers who are not legally separated or divorced on December 31 are considered married for the tax year. In those situations, the individuals can file as “married filing jointly,” “married filing separately,” or “head of household.” There will be an overall tax bill with the “married filing jointly” status, but the spouses will not have to file the return together.
A “head of household” filing status can be more advantageous than a “married filing separately” or “single” filing status, especially if there are any dependent children. If the taxpayer did not live with the spouse for the last six months of the year, they could file as “head of household.” The taxpayer must have paid more than half of the household costs to use this status. Along with that, the children must be qualifying dependents and live with the taxpayer for more than half of the year.
There are many options to file taxes for separated or divorced individuals. In any case, the individual will need to figure out their amount of income. Most couples will file a joint return with the combined income while married. The income is usually not broken down to determine how much money belongs to each partner. However, that changes with a divorce.
By determining the proper allocation of income, the taxpayer can find the best filing option for their taxes. In most states, community property must be equally split up to the date of the divorce. Once the divorce has been finalized, the taxpayer will need to report their income from that date to the end of the year. Those living in an equitable distribution state must report all income individually. Along with that, the taxpayer should document their personally owned property as well.
Attorney Fees Are Not Deductible
Many couples might wonder if a divorce lawyer or tax planning fees are deductible. Unfortunately, these fees do not qualify as deductible fees. Since January 1, 2019, legal and professional fees are not deductible for individual taxpayers on a federal level. However, on January 1, 2026, that deduction will be allowed again. Some states do allow a tax deduction for these fees.
Overpayment Can Be Allocated Between Spouses
In some situations, an individual can overpay on their taxes. According to the IRS, if that overpayment was applied to the next year’s taxes, those payments can be allocated between the spouses. This allocation must be agreed upon, and an explanation needs to be attached to the tax return.
Some states dictate the amount of allocation of these payments. Both spouses could allocate these payments equally if the divorce occurred in a community property state. In addition to that, those payments must have been made with community funds. Estimated tax payments are divided between the spouses. Those payments are proportional to each individual’s tax liability in equitable distribution states.
Seek Help from an Experienced Divorce Lawyer
A divorce settlement can affect your tax status. While an attorney is not a professional tax preparer, they can still provide advice to point you in the right direction for your taxes. All assets and liabilities can affect your taxes for several years, even after the divorce has been finalized.
The Law Office of Kelly Berton Rocco can help with your divorce case. If you are in the middle of a divorce, an attorney may be able to help you navigate this confusing process. You can schedule a consultation by calling the Hackensack office at 201-343-0078 or by submitting our contact form.