Divorce and taxes: What do I need to know?
Those going through a divorce likely know the basics about splitting property. Ideally, they come up with an agreement on their own, but if they cannot they realize that any property acquired during the marriage is likely subject to division. In some states, the court will do its best to split the assets as equally as possible. In others, like Tennessee, the courts will apply the principal of equitable distribution and attempt to split the property as fairly as possible.
In both situations, the divorcing parties need to take another factor into consideration — taxes.
Let’s be honest, no one likes to deal with the Internal Revenue Service (IRS). In the best years, we file our tax returns and wait for a refund. In the worst, we file our returns with an additional payment or even get a letter from the tax agency saying we may be subject to an audit. Thinking about dealing with the IRS during one of the most difficult times of our lives, divorce, is not ideal. The good news is that divorcing couples generally do not have to pay taxes when they shift property from one spouse to another. The bad, there are other ways taxes still impact your assets and a failure to take this into account before finalizing divorce can result in some financially devastating results. The following will delve into three specific ways taxes impact divorcing couples.
#1: The kids.
If you have children, they play a pretty big role in taxes. For one, the parents will need to decide who can claim the child tax credit. Generally this goes to the custodial parent, but some will agree that the non-custodial parent can take this credit. This is possible, but the custodial parent will likely need to sign a waiver in order for the non-custodial parent to take this credit.
It is also important to note that the IRS does not allow the person paying child support to take it as a tax deduction, nor does it expect the person receiving the child support to claim it as income.
#2: Property taxes and capital gains.
Although you do not have to pay taxes to shift ownership of property from one spouse to another during divorce, you do become responsible for the taxes that are associated with that asset after the shift is complete. That means you will need to take over for the tax payments in the future.
For real estate, like the family home, that means paying the property tax bill annually. It can also mean paying any capital gains tax on real estate, stocks, or other assets when they are sold. This is important: if you plan to take the family home or another asset only to sell it shortly after the divorce is finalized you could find yourself facing a very big tax bill.
#3: Tax breaks and deductions are not what they used to be.
In the past, a person paying alimony or spousal support could take the payment as a tax deduction. This was beneficial for the person asking for alimony, as they could use it as a negotiating tool. But the law changed. As it does. A few years ago the Tax Cuts and Jobs Act (TCJA) made huge changes to tax law. The part that applies to this discussion is the fact that alimony is no longer a tax deduction. As a result, any divorce finalized after 2018 can no longer take advantage of this tax break. Those who pay alimony and finalized their divorce prior to 2018 can still claim alimony payments as a tax deduction. It is important to note that those divorces grandfathered in would lose this deduction if they modify their divorce agreement after 2018.
This is an example of the need to find professional help that will not only be aware of the need to look into the impact of taxes on the divorce but will also stay current on any potential changes. The intersection of family law and tax law is always evolving, and it is important to know if any of these changes will impact your situation.