Understanding Tax Implications During Divorce
Co-Author: Gregg Greenstein, Esq.
If you are going through a divorce or separation, taxes may be the last thing on your mind. However, poor tax planning during this process can lead to huge headaches down the road. We have experience helping clients navigate the potential tax pitfalls that can negatively impact their marital estate. We can work alongside your divorce attorney to ensure that provisions included in divorce agreements or settlements resolve tax issues to your benefit.
What are some of the tax issues that should be discussed during and before divorce or separation?
1. Changes in your Tax Rate. Filing status, claiming dependents, real estate, and asset liquidation can all affect your tax bracket. We can help address the various factors that can impact your tax liability. The Tax Cuts and Jobs Act suspended personal exemptions through 2025. However, several other tax breaks depend on claiming exemptions. Those tax breaks include but may not be limited to:
- a. Head of Household Filing Status
- b. Child Tax Credit
- c. The Credit for Other Dependent
- d. The Child Care Credit
- e. The Earned Income Tax Credit
- f. Education Tax Credits
- g. The Student Loan Interest Deduction
- h. The Medical Expense Deduction
If these or any other exemption, deduction or credit or payment is available based on claiming a dependent child on a tax return, the exemption, should be allocated as part of the divorce settlement or permanent orders.
2. Alimony (Maintenance) Payments. For all divorces finalized after January 1, 2019, alimony payments are no longer tax deductible for the spouse who pays them and are not considered as income for the spouse who receives the payment. This should be taken into consideration before writing a divorce settlement as it can have a negative impact especially on the spouse who will be paying the alimony. The maintenance formula and standards are supposed to take into account the fact that maintenance is not deductible nor income.
3. Non-liquid assets. Although some funds can be transferred tax and penalty-free with a certified divorce decree (for example, an Individual Retirement Account (IRA)), others will require what is called a Qualified Domestic Relations Order (QDRO). Transfers involving QDROs must be handled in accordance with IRS regulations to be treated as tax and penalty free. The cost for drafting a QDRO can be in excess of $1,000 and thought should be given as to how to allocate that cost.
4. Tax credits and carryovers. Tax credits and carryovers can have significant value, just like your assets. The division of these items should be discussed before any agreements are finalized.
5. Status of prior tax returns – Have prior tax returns been filed and tax balances paid? As part of the divorce settlement, it will be very important to determine the status of prior tax returns. It’s also important to address what happens if there is a future tax liability resulting from an audit, or a future refund for years when the parties filed jointly. The refund check or liability notice might get sent to the address shown on the tax return, and if you have moved, or if your ex-spouse is at that address, you may not receive notice. That can be addressed in settlement negotiations or in the permanent orders.
The Importance of Consulting Tax Professionals in Divorce
Every divorce/separation situation is unique and requires careful tax planning to avoid negative results. Consulting a divorce attorney and/or a tax attorney now can alleviate financial burdens in the future. Contact Jeff Cohen if you have any tax questions and Gregg A. Greenstein, if you have any divorce questions.
