Exploring the Tax Implications of Divorce

Tax season is right around the corner. Millions of Americans are readying their paperwork and steadying their nerves – both of which will be required to submit those tax returns on time. If you are in the process of a divorce or about to start one this year, let’s explore some tax implications that are baked into the process so that you can be better prepared for what to expect next. 

what are the tax implications of divorce?

How Divorce Affects Taxes

The biggest change to your taxes will be your filing status. You may submit a “married” filing tax return until the divorce is final. The calendar year in which your divorce is finalized and Judgment entered by the court terminating your marital status is the operative time period. You are legally married until this date. Until you are restored to the status of a “single” taxpayer, you may file “married” jointly or separately with your former spouse. A joint tax filing carries many implications and requires consent of your former spouse. If you have been legally separated or living separately for a period of time, then you may be able to file as “head of household”. Consult with your tax preparer for the most advantageous filing status for you.

Alimony & Child Support

Alimony (or “spousal support”) is no longer tax deductible by the payor or taxable to the payee for judgments entered after 12/31/18 as a part of the changes to the federal tax code. Prior to this time period and for many years, alimony could be deducted which was often a benefit for both payor and payee. However, depending on your state, you may still owe taxes on alimony on a state tax return (such is the case in California which for now has not conformed to the federal tax code changes). Child support is never taxable to the payee nor deductible to the payor.  

Taxes on Assets and Asset Transfers

In most cases, the IRS does not consider the transfer of assets between divorcing spouses as a taxable event. Consequently, the transfer of cash, real property, retirement accounts and other assets between spouses as a result of a judgment of divorce is tax-free. You may be subject to a capital gains tax on mutual funds, stocks, and bonds when you sell them to divide the assets. When dividing assets, you should keep in mind that depending on the asset type, it may have embedded tax consequences down the road that should be considered when you are dividing the marital estate  — in particular if you are choosing to equalize one asset type against another (e.g. a traditional 401K account which requires payment of taxes at the time of distribution).

Real Estate Sales Taxes

A home is oftentimes the most expensive jointly owned asset in a marriage. In the divorce, you can choose to sell the house and split the proceeds or allow one party to buy out the other’s equity in the property. Selling the home and dividing the net sales proceeds proportionately between spouses is typically the cleaner transaction and allows both spouses to exclude a larger portion of the capital gains taxes which may be due. If you elect to buy-out your spouse’s interest, any taxable capital gain incurred in future years will be your sole responsibility. 

Tax laws can be incredibly complex and their application very fact-specific. To top it off, tax laws change every year depending on new legislation and public policy shifts. You are well advised to consult with a qualified tax professional to guide you through the tax issues that come up around the divorce process  – division of assets, payment of support, and appropriate estate planning for your family.