Getting a divorce is already a difficult experience. You and your spouse must figure out how to split your assets, come to an agreement regarding child custody, and negotiate issues concerning child and spousal support. In addition, feelings of resentment, anger, and rejection may bubble to the surface, triggering unnecessary arguments.
But taxes can make the situation far worse. If you and your future ex-spouse neglect to plan ahead, one or both of you may be stuck with a nasty tax bill at the end of the year.
With that in mind, we’ll provide a few tax-related suggestions below that can help reduce the amount you owe the Internal Revenue Service at the end of the year. The following should not be construed as tax advice. We highly advise consulting a qualified tax professional who can make recommendations based on your personal circumstances.
Limit The Amount Of Alimony You Receive
If you intend to pay alimony, you can write off the payments on your federal income tax (you don’t need to itemize to take advantage of the deduction). But be aware that the payments are not tax-deductible if you and your spouse continue living in the same house.
If you’re the person receiving alimony payments, it’s important to realize the payments will be treated as taxable income by the IRS. Expect them to increase your end-of-the-year tax bill. It may seem unfair, but the IRS is very strict about the matter.
One solution is to ask your spouse to reduce the amount paid in alimony payments and increase the amount paid in child support payments. Child support is tax-neutral. The payments cannot be deducted, nor are they counted by the IRS as taxable income. (This solution assumes that you and your spouse have dependent children.)
Use The Proper Filing Status When Filing Your Taxes
In most cases, couples filing their taxes jointly make out better than couples filing their taxes separately. When getting a divorce, your filing status is dictated by whether you were officially married on the last day of the calendar year. If your divorce was finalized by December 31, you must file separately, either as head of household or a single person.
Depending on your circumstances, it may behoove you and your spouse to postpone making your divorce final until the beginning of the year. That way, both of you can still benefit from the tax advantages of filing jointly.
Sell The Family Home While Married
The family home presents a unique challenge during divorce based on the homeowner’s tax filing status. When you sell your house, you are expected to pay taxes on the capital gains realized from the sale. However, if the homeowner can meet certain requirements, he or she can qualify for an exclusion. The IRS allows single homeowners to exclude $250,000 in capital gains from their tax bill. Married couples can exclude $500,000 in capital gains.
Suppose you get the house in the settlement, and want to sell it the following year. Further suppose the property has appreciated in value by $400,000 from its original purchase price. As a single person, you can only exclude $250,000 in capital gains. You’ll have to pay taxes on the remaining $150,000 of appreciation.
Try to negotiate a settlement agreement that takes this factor into account. It may be an even better idea to sell the property while you and your spouse are still married. That way, you’ll be able to take advantage of the $500,000 exclusion.
Use A QDRO For Retirement Assets
Oftentimes, divorcing couples liquidate retirement accounts – 401ks, etc. – to split the assets contained in them. The problem is that doing so is considered a taxable distribution by the IRS. That means the account owner will need to pay taxes on the amount withdrawn.
The proper way to handle asset transfers from retirement accounts during divorce is to complete a Qualified Domestic Relations Order (QDRO). Using this form will allow the account owner to avoid being on the hook for taxes as a result of a distribution.
Can You Claim Your Child As A Dependent?
If your divorce settlement specifies that you are the legal custodian for your child, you may be eligible to claim him or her as a dependent. Doing so can significantly reduce your end-of-the-year tax bill.
Many divorcing couples share joint custody of their children. In that situation, the person with whom the child spends a majority of the year gets to claim him or her as a dependent. One solution is to switch the dependency between the spouses from year to year. Doing so allows both parties to take advantage of the tax benefit.
Taxes are a complicated matter, even outside the context of a divorce. If you haven’t already done so, speak with an experienced divorce attorney who can advise you on dissolving your marriage. At the same time, consult a professional tax accountant for advice on minimizing the amount of money you’ll owe the IRS.