Divorce is hard enough without having to worry about taxes too. But taxes are inevitable. And a divorce adds a new layer of complication to tax preparation and tax planning. No one wants to overpay their taxes as the result of a divorce.
Filing Taxes After Divorce
We have identified a list of common tax questions that our divorcing clients ask when they call our Atlanta-based CPA firm.
Read on to know learn some of the important tax questions to ask, and the answers to those questions, when you are going through a divorce.
Taxes During Divorce: Who Claims the Child Tax Credit?
Only one person can claim the tax benefits related to a dependent child. Tax benefits are not split between the divorcing parents. Two people may not claim the same child on their tax returns.
The custodial parent will generally claim the child as a dependent on his or her tax return and will be able to use the tax benefits related to that child. The custodial parent is defined as the parent with whom the child lived for most of the year.
The custodial parent can release the tax benefits to the noncustodial parent. This is done by signing a written declaration or Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. The noncustodial parent submits this declaration or form with their tax return.
Sometimes parents with shared custody will agree to claim the child tax credit in alternative years.
Is Alimony Taxable?
The 2019 Tax Cuts and Jobs Act completely changed the tax rules for alimony.
Under the new rules, alimony received relating to divorces settled after December 31, 2018 is not taxable.
Is Alimony Tax Deductible?
Similarly, under the new rules, alimony payments for divorces settled after December 31, 2018 are not deductible.
How is Alimony Taxed: Divorces Settled Before 2019
For divorces settled prior to the 2019 tax law change, alimony received is taxable and alimony paid is deductible.
This only applies to payments that qualify as alimony. The requirements for alimony are:
- The spouses do not file a joint return with each other
- The payment is in cash (including checks or money orders)
- The payment is to or for a spouse or a former spouse made under a divorce or separation instrument
- The spouses are not members of the same household when the payment is made
- There is no liability to make the payment (in cash or property) after the death of the recipient spouse
- The payment is not treated as child support or a property settlement
- The divorce or separation agreement does not designate the payment as not includable in gross income of the payee spouse and not allowable as a deduction to the payor spouse
The pre-2019 tax rules for alimony were beneficial when the payor of alimony is in a higher tax bracket than the recipient of the alimony. This reduced the taxable income of the payor. And, because the alimony received is taxed at a lower rate, there was more money between the two of them to share.
Alimony Recapture
The alimony recaptures provisions of the Tax Code apply to divorces settled before 2019. These rules are intended to prevent taxpayers from improperly characterizing property settlement payments as alimony for tax purposes. We will save this topic for a separate article in the future.
Alimony Modifications
For divorces finalized prior to 2019, the parties have the option to adopt the new tax rules for alimony as established by the 2019 Tax Cuts and Jobs Act.
This may be advantageous when:
- The payor of alimony is now in a lower tax bracket and no longer needs the deductions
- The recipient of alimony is now in a higher tax bracket and does not want to pay tax on the additional income at a higher marginal tax rate.
Are Child Support Payments Taxable?
Child support is not taxable to the recipient.
Are Child Support Payments Tax Deductible?
Child support payments are not deductible to the payor.
Tax Filing Status (Pre-Divorce and Post-Divorce)
Married Filing Jointly or Married Filing Separately
For many couples, the married filing jointly tax status results in a lower tax than married filing separately. Married filing jointly required a joint tax return. Married filing separately requires two separate tax returns, whereas a filing jointly requires one joint tax return.
However, the filing status of married filing jointly means that both you and your ex spouse are jointly liable for the tax debt, which is frequently a cause for concern in a divorce setting. With this in mind, the filing status of married filing separately may be better, even if that means you are subject to a higher tax rate. However, professional fees are generally higher when filing separate tax returns, as two tax returns are ususally required.
You cannot amend a return at a later date to switch from the filing status of married filing jointly to the filing status of married filing separately. This may not be used to eliminate the joint tax liability that comes with married filing jointly.
Head of Household if You Pay More than Half of the Expenses
Once you have a divorce or separation agreemenet with your ex spouse and your divorce is finalized, you will start filing taxes either as single or head of household. Individuals may use head of household status if they can claim a dependent child who lives with them in their home, provided it is the dependent’s main residence and the individual pays for more than half of the home’s maintenance for at least half the year.
Head of household offers lower tax rates than married filing single. For this reason, the filing status of head of household is often desired once the divorce or separation agreement is in place. For this reason, be sure to keep track of your expenses in case you need to prove to the government that you met the “more than half” expense test when filing taxes as head of household.
Head of household status requires the filing of one return.
Estimated Tax Payments for the Tax Year
Once the divorce or separation agreement is final, remember to adjust your quarterly estimated tax payments for the tax year in light of your new tax liability. The is particularly important if you have a business or receive non-wage income that is not subject to tax withholding. Paying estimated tax payments for the tax year avoids the surprise that you may owe tax when you filing your returns.
Adjusting for estimated taxes for the tax year minimizes the risk of penalties and interest on both your federal return and state return.
What about Unfiled Tax Returns from Before Your Divorce?
The divorce court will want you to have tax returns filed and up-to-date. There are two reasons for this: to tie up the loose ends, and to provide the financial information needed for alimony and child support calculations.
What if you don’t know if your ex-spouse filed all the tax returns? In this case, you can contact the IRS to get your IRS transcripts which will show which tax returns, if any, are missing. You can also ask your CPA or otohehr tax professional to obtain thhis for you.
IRS transcripts also provide details of 1099’s and W-2’s, which sometimes go missing during a divorce. Your attorney will probably find that useful when calculating child support and alimony.
Property Transfers When Legally Divorced
Income tax on property transfers may be an issue as well.
It is common that marital assets are distributed to the spouses once they are legally divorced. This includes, for example, the marital residence, businesses and retirement assets. The tax implications of property transfers should always be considered during the negotiation process.
Most transfers of property between the spouses as the result of a divorce decree are non-taxable. Meaning, there is no gain or loss.
You may have to pay income tax in the future if you sell assets that you received as a result of a divorce. However, do remember that there is an exclusion on the sale or a primary residence ($250,000 if you are single, $500,000 if you are married), provided that the house was used as a principal residence for two of the last five years. Don’t forget about these potential tax issues, even if they are in the future.
Do You Have to Pay Taxes on a 401k Settlement as Part of a Divorce Agreement?
There is no income tax liability when retirement plan assets are transferred from one spouse to another spouse as the result of a divorce agreement.
The funds will be kept in a retirement account for the receiving spouse. Income tax and penalties after the end of the year may apply if the receiving spouse takes an early distribution.
Should I Change My Tax Withholding After Divorce?
Remember to update your withholding taxes (payroll taxes) after your divorce. This is done on IRS Form W-4. This ensures that you claim the proper amount of withholding. You don’t want to withhold too much (which is giving a loan to the government) or too little (which results in taxes owed on April 15 and possible interest and penalties).
Joint Tax Returns and Joint Liability for Former Spouses
If you file jointly, both former spouses are equally responsible for the taxes. This is called joint and several liability. The IRS will go after either party for unpaid taxes.
If the divorce decree says that either the husband or wife is responsible for the taxes, that is not binding on the IRS.
Check out our article on Joint Returns and Joint Liability for more detail on this topic.
There is possible exception to the rules for joint liability for former spouses. If one spouse claims that they he or she had no knowledge of the income activities of the other spouse, despite the fact that they file jointly, the objecting spouse may request IRS relief under the Innocent Spouse Rules.
What If I Do Not Trust Previously Filed Tax Returns?
If you do not trust that the previously filed tax returns are accurate, then you can file amended returns, provided that your spouse agrees.
Expect your spouse to object. You may need an attorney at that point.
What If I Do Not Trust Our Current Accountant?
Does your accountant play golf with your ex-spouse? If so, you may want to find a new CPA or tax accountant. Look for someone who is independent, will represent your interests and is able to provide you with impartial tax advice. You always want to be sure that the income reported on your returns after the end of the year is not overstated.
Check out our article on Conflict of Interest for details on this topic.
What If I Can’t Pay Taxes?
It may be time to start negotiating with the IRS for a tax resolution. Options include Penalty Abatement, Offer-In-Compromise, Installment Agreement, or Currently Not Collectible Status.
The important thing is to know that tax relief is a real option. It just requires negotiation. In the meantime, continue to file tax returns and be responsive to all IRS letters and notices. If you handle tax debts responsibly, the IRS will work with you.
Check out our article here on IRS Negotiation and Resolving a Tax Debt.
What Happens if You Don’t File a Tax Return?
Even if you cannot afford to pay taxes, file taxes anyway. This will minimize the penalties and interest that you will owe to the IRS and your state Department of Revenue. It starts the statute of limitations running on your tax returns. And it shows the IRS and the state that you are willing to cooperate, follow the rules and be a good citizen, which is very important to them.
You don’t want to be categorized as a non-filer or have a missing tax form on your record.
So, first file taxes. Then, if you cannot pay, start to negotiate a deal.
Tax Lien on a House
The IRS will work with you to discharge or subordinate a lien so that you can sell a house, or another other property, pursuant to a divorce. The IRS would rather you be able to sell the house and pay off some or all of your tax debt, rather than leaving you stuck with both unpaid taxes and an unwanted house.
Tax Planning and the Divorce Process
Ask your CPA, Enrolled Agent or tax accountant to do some tax planning for you related to the divorce. The tax planning should include a tax projection that shows the after-tax cost of various divorce-related financial matters. These include:
- Who is Going to Claim the Children? While children no longer provide dependency exemptions, there are child tax credits and earned income credits which need to be considered.
- Head of Household Filing Status – You will want to run a projection that shows the after-tax benefit of this filing status post-divorce.
- Future Tax Liabilities – You will want to know now if you can afford to pay future taxes on your income.
A tax projection will be extremely helpful to you when you are negotiating your divorce. This will provide clarity on the after tax cost of various decisions that you are making. A tax projection is often critical for divorce negotiations.
And tax planning in general is very good medicine for everyone. The benefit will almost always exceed the cost.
If you need additional answers to your tax-related questions, please give us a call at 678-235-5460 or 773-828-0551.
Or email us at gary.massey@masseyandcompanyCPA.com
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Massey and Company CPA is a boutique tax and accounting firm serving individuals and small businesses in Atlanta, Chicago and throughout the country. Our services include tax return preparation, tax planning for businesses and individuals, IRS tax problem resolution, IRS audits, sales tax, and small business accounting and bookkeeping.
