Tax and Practical Implications of Divorce

Divorce is a difficult and emotional process, and it’s important to surround yourself with professionals to guide you through the process and prepare you for the days ahead. In fact, it is critical to have a family law attorney and a divorce financial planner on your side throughout to ensure the best financial outcome possible.

While not all inclusive, the list below will give you a broad overview of those tax and practical points of which you should be aware.

Support/Alimony Payments

The tax law passed in December 2017 made changes to alimony payments. Starting in January 2019, alimony payments are no longer deductible to the paying spouse. Neither are these payments eligible for inclusion in gross income for the recipient spouse. 

Divorce agreements that were executed before 2019 are subject to the old rules, even if they are modified in 2019 or beyond. Ex-spouses may choose, however, to have their modified agreements follow the new rules where payments are no longer taxable or eligible for deduction.

Dependency Exemptions

While dependency exemptions for children remain suspended until 2026, there are other important credits that may be available to you if you can claim your child as a dependent. These include the child tax credit and dependent care credit, among others.

In order to claim your child, you must be a custodial parent, regardless of what your divorce decree says. A custodial parent may release the exemption to the non-custodial parent by signing Form 8332. This form may be signed for one year or multiple years (i.e., every odd year). 

The custodial parent may revoke a previously released exemption by using Part 3 of form 8332 and attaching a copy of the revocation to their tax return for each year the release is being revoked. 

Property Settlements

Usually, no gain or loss is recognized when property is transferred between spouses or ex-spouses, as long as the transfer is incident to a divorce. The receiving spouse takes the same basis in the property as they held when the property was jointly owned. Thus, if you get a vacation home as part of your settlement and your spouse bought it for $250,000, your basis in that house is $250,000. Should you later sell that vacation home for $300,000, you will recognize a gain of $50,000 and pay tax on that amount. If you designate that vacation home your principal residence for at least two years and sell it for $300,000, you will exclude all of that gain.

A personal residence, if sold, will typically result in no taxable gain because married couples who lived in and owned their house for at least two years can exclude up to $500,000 of gain (due to appreciation). Even if one spouse moves out, they can still avoid the gain in the same manner and their divorce agreement may have specific language to protect this exclusion for the spouse who moves out.

Update Your Estate Documents

If you happen to have a will and an estate plan, you will need to consult with an estate attorney to make changes to your documents. You will also need to address trustee issues and guardianship issues for minor children. Review your beneficiary designations on all your retirement accounts (such as your 401(k) and any IRAs), and make sure those beneficiaries are really the people you want to inherit your money.

Medical Insurance

If your spouse participates in a health plan that is subject to COBRA, you will be able to obtain coverage for up to 36 months following your divorce. Even if your spouse took you off the plan while your divorce was pending, you will be able to buy COBRA health care coverage. You will have to pay for the coverage out of pocket, however, unless your divorce decree mandates your spouse make those payments for you. 

Tax and Financial Records

Prior to divorce, you will need to secure access to copies of your tax returns, preferably for the last five years, along with any supporting documents used to prepare your tax return. Also, make sure you have at least a year’s worth of all credit card statements and brokerage statements. If you are going to keep your house, keep your closing statement and documentation of any major improvements you did on the home secure and available. 

Filing Status

If your divorce isn’t final by December 31, you are considered married for the preceding year and will need to file your taxes as filing married, either jointly or separately. Separate filing usually results in greater tax liability and is more complex due to the income splitting you have to do with your spouse. But if you believe that your spouse may be underreporting income, it might make sense to consider filing separately so that you aren’t subject to tax liability due to your spouse’s actions.

If your divorce was finalized by December 31, you will file as a single person, or head of household if you have a dependent child. 

Adjust Income Tax Withholding

When you get a divorce, you should prepare a new Form W-4 and submit it to your employer. This form also allows you to have an extra amount withheld from each paycheck, which is helpful when you expect additional, non-W-2 income to be reported on your tax return. By working with a tax professional, you can get an accurate tax liability estimate and spread those payments over several months to help smooth out your cashflow.

Notify the IRS of Your New Address

If you are going to change your address due to a divorce, you should notify the IRS of your new address by filing Form 8822. This will ensure that any notices from the IRS will go to the right place. 

The IRS gives us a timeline within which to respond to their notices and failure to respond by that date could cost you in penalties and interest. When you look for a divorce financial planner in Dallas, consider hiring one who has a tax background—this experience allows them to provide tax advice and help guide your decisions that will have immediate and future tax implications on your divorce settlement. Freeze Sulkov can serve in just such a capacity: give us a call at 214-761-8304 or reach out to us via our website.

From the desk of Maksym Sulkov, CPA/PFS.