People going through a divorce may not consider tax implications until it’s too late. Both parties should take steps to minimize taxes and tax-related decisions are properly made with a tax advisor before the divorce is final. Here are four issues to understand regarding taxes and divorce.
- Alimony or support payments. Divorce or separation agreements for alimony that are executed after 2018, there’s no deduction for alimony and separation support payments for the spouse making them. In addition, the alimony payments aren’t included in the gross income of the spouse receiving them. (The rules are different for divorce or separation agreements executed before 2019.)
- Child support. No matter when the divorce or separation instrument is executed, child support payments aren’t deductible by the paying spouse, nor are they taxable to the recipient.
- Personal residence. In general, if a married couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (as long as they’ve owned and used the residence as their principal residence for two of the previous five years). If one spouse continues to live in the home and the other moves out – but they both remain owners of the home – they may still be able to avoid gain on the future sale of the home (up to $250,000 each). However, you may need to include special language in the divorce decree or separation agreement to protect the exclusion for the spouse who moves out.
If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.
4. Pension benefits. A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a “qualified domestic relations order” (QDRO). This gives one spouse the right to share in the pension benefits of the other and taxes the spouse who receives the benefits. Without a QDRO the spouse who earned the benefits will still be taxed on them even though they’re paid out to the other spouse.
Consult a tax advisor
These are just some of the issues you may have to deal with if you’re getting a divorce. There are other considerations, such as how you will file your tax return (single, married filing jointly, married filing separately or head of household). You may need to adjust your income tax withholding and don’t forget to notify the IRS of any new address or name change. If you have an estate plan, there are additional planning considerations. Give us a call, we can help you work through all of the financial issues involved in divorce.