Couples seeking a divorce must take into account numerous tax issues. From the sale of the family home to the manner in which both parties file their taxes – jointly or otherwise – several potential pitfalls lie in their path. Failing to consider such details can result in a large, unexpected tax bill at the end of the year.
To help you to avoid these problems, we’ll address several tax-related issues related to divorce below. We’ll begin with a brief discussion about the sale of your home and how it might affect the amount you own the Internal Revenue Service (IRS). You’ll also learn about the tax implications associated with alimony and child support. Lastly, we’ll cover the appropriate filing status given your circumstances.
The information that follows should not be considered tax advice. It is highly advisable that you consult a trained accountant before filing your taxes in order to avoid problems.
Taxes On The Sale Of The Family Home
Twenty years ago, the sale of a couple’s principal residence posed a bigger tax repercussion than it does today. Selling the home often resulted in a large capital gains tax, which the couple would be forced to pay at the end of the year. The Tax Reform Act of 1997 changed that.
With this “new” law, homeowners can qualify for an exclusion. They can exclude up to $250,000 of the capital gains realized on the sale of the house if they are single, and $500,000 if they are married. For most divorcing couples, this $500,000 exclusion is enough to eliminate the capital gains tax on their homes.
One of the conditions that applies to the capital gains exclusion is that the homeowners must have used the house as their principal residence for 2 of the previous 5 years. This is fine for divorcing spouses who sell their home shortly after dissolving their marriage. But oftentimes, couples retain ownership after one of the spouses moves out. If 3 years pass, the house can no longer be considered the couple’s principal residence. Selling it after that point may result in a substantial tax bill.
Tax Issues Involving Child Support And Spousal Support
Child support and spousal support present interesting tax issues because they are treated in opposite manners from a tax liability perspective. Child support payments are not considered a part of the receiving spouse’s taxable income. Neither are the payments tax-deductible for the paying spouse.
Payments for spousal support are considered to be a part of the receiving spouse’s taxable income. They are also tax-deductible for the paying spouse.
Given the tax implications surrounding both types of support, most receiving spouses prefer to receive the bulk of the payments in the form of child support. That way, their tax liability is smaller. However, paying spouses prefer to provide as much of the support as possible in the form of alimony. That allows them to deduct a larger portion of the support payments from their annual tax bill.
The income levels of both parties may make spousal support a better option from a tax perspective. The amount that can be deducted from the paying spouse’s taxable income might make it feasible to raise the amount of the payments. An experienced divorce attorney and accountant can review both parties’ income levels, and advise them on the most advantageous approach.
Filing Status During And After A Divorce
A couple’s filing status is dictated by the date their divorce is made final. If they are still married at the end of the year (December 31st), they should note their married status on their tax returns for that year. They can still file separately despite their married status.
If the couple’s divorce is made final before the end of the year, both spouses should file their returns separately with each spouse noting his or her single status. The length of time the couple was married during the year does not matter. Nor does the period they spent living together during the year.
There are several other important tax issues divorcing couples should consider before they officially dissolve their marriages. These can involve the exchange of property, one-time payments made to satisfy a settlement agreement, and tax exemptions for kids. The complexity of these and other issues warrant hiring a divorce attorney and accountant with experience in handling such cases.