General Tax Pointers : How Divorce Affects Your Taxes
In addition to being an unsettling time, separation or divorce has numerous tax implications. Whether you’re separated or divorced your taxes are affected in several ways, including:
- Filing Status: If you are separated but have not obtained a final decree of divorce or legal separation by December 31 of that tax year, you can only file as Married Filing Jointly or Married Filing Separately, since you are considered married for the entire year. If you are divorced or legally separated by December 31, you are considered not married for the entire year and you can file as Single, or Head of Household if you have a qualifying dependent.
- Dependents: When you’re not yet legally separated or divorced, you and your spouse can claim your dependent children on one joint tax return or file separate returns with the Married Filing Separately status and have one child claimed per return. If you are divorced and have a divorce decree naming one parent the custodial parent, only the custodial parent can claim the dependent child.
- Health Insurance Coverage: During separation, your health insurance coverage usually does not change. However, if you lose coverage due to a divorce, it is considered a “life event” that allows you to enroll in health coverage through the marketplace during a special enrollment period. Alternatively, you may decide to take on health insurance through your employer for the first time, if your former spouse provided your health insurance. Amounts of premium payments which (i) are paid out-of-pocket by you; and (ii) are paid after taxes are taken out (also called “post-tax income”) may be tax deductible.
- IRA Retirement Account Contributions: If you are not legally separated or divorced by December 31 of a tax year, you will be able to deduct any contributions you make to your ex-spouse’s traditional IRA. Otherwise, you can only deduct contributions to your own traditional IRA.
Alimony Payments and Taxes
In order to determine whether you can deduct (as Alimony Payer) or must report (as Alimony Payee or Recipient) alimony payments, the year in which your divorce or separation was finalized is the deciding factor.
2018 or Any Prior Year Finalized Divorce or Separation Agreement
Alimony Payer: You can deduct alimony payments you make to your former spouse on the federal and state income tax returns for the tax year you make the payments. The new tax law changes of 2018 regarding alimony payments do not apply to you on your 2018 tax return or any tax return before or after, if you divorce or separation agreement was finalized during 2018 or any prior year. Consult with a lawyer to review your separation or divorce agreement regarding these distinctions.
Generally, you can claim your alimony payments as a tax deduction if:
- They were in the form of cash, checks or money orders;
- They were authorized by a court order for legal separation or divorce;
- They were made when you and your spouse were not members of the same household;
- They were terminated upon your receiving spouse’s death;
- They were spousal support, not a part of a child support payment or property division;
- They were includable in your receiving spouse’s taxable income; and
- You and your spouse did not file a joint tax return.
Alimony Payee or Recipient: You must report the alimony payments you received from your former spouse as income on the federal and state income tax returns for the tax year you received the payments. The new tax law changes of 2018 regarding received alimony payments do not apply to you on your 2018 tax return or any tax return before or after, if your divorce or separation agreement was finalized during 2018 or any prior year. Consult with a lawyer to review your separation or divorce agreement regarding these details. You must report alimony payments received if they were made by the Alimony Payer to you in any of the forms listed above under the Alimony Payer section.
2019 or Any Prior Year Finalized Divorce or Separation Agreement
2018 changed the landscape of alimony and reporting with tax forms. If your divorce or separation agreement was finalized during 2018 or prior, alimony payments – whether paid or received – are permanently grandfathered into the alimony tax rules before the tax changes of 2018. After 2019, the following changes apply:
Alimony Payer: You cannot deduct your alimony payments you make to your former spouse on federal and state income tax returns for the tax year you make the payments. The new tax law changes of 2018 regarding alimony payments do not apply to you on your 2019 tax return or any tax return after, if your divorce or separation agreement was finalized during 2019 or any later year. Consult with a lawyer to review your separation or divorce agreement regarding these details.
Alimony Payee or Recipient: You do not need to report the alimony payments you received from your former spouse as income in the federal and state income tax returns for the year your received the payments. The new tax law changes of 2018 regarding received alimony payments do not apply to you on your 2019 tax return or any tax return after, if your divorce or separation agreement was finalized during 2019 or any later year. Consult with a lawyer to review your separation or divorce agreement regarding these details.
Child Support and Taxes
Child Support Payer: You cannot deduct child support payments you made to your former spouse on your income tax return. Unlike alimony, nothing changes as a result of the new tax reforms of 2018 for child support payments as it relates to your taxes. Child support is for your child or children and is paid to the spouse who lives with the children. Unless you divorce or separation settlement states that the payments should be considered alimony, you cannot deduct child support payments.
Child Support Payee or Recipient: If you received child support payments, you do not have to report them as income on your tax return since the payments are tax free, regardless of the year when your divorce or separation agreement was finalized.
Who Can Claim a Child as a Dependent after a Divorce or Separation?
As a general rule, a child can only be claimed on one of the divorced/separated parents’ tax return. You claim your child as a dependent on your tax return if the divorce decree or legal separation agreement names you as the custodial parent. In the absence of a clear provision, the child is your dependent if the child lived with you for a longer period of time during the tax year than the child lived with your former spouse. However, if both you and your former spouse attempt to claim the same child dependent, the IRS will apply tie-breaker rules to determine which former spouse qualifies to claim the child.
Starting with tax year 2018 and ending with tax year 2025, the dependency exemption for dependent children has been abolished. For previously filed divorces, only one parent can claim the dependency exemption. The parent who claims the dependency exemption is also entitled to the $1,000-Per-Child Tax Credit for children under 17, assuming his or her income is not too high. This is usually a straightforward determination if you have a divorce decree which names the custodial parent. If not, you are considered the custodial parent if your child lived with you for a longer period during the year than the child lived with your former spouse. Sometimes the noncustodial parent can claim the exemption if the custodial parent signs a waiver pledging that he or she won’t claim the child. Sometimes, a parent will claim the dependent tax exemption when they are not entitled it. If your former spouse files his or her tax return before you do, it is possible that he or she would be allowed the exemption, at least temporarily.
Other Income Tax Return Considerations
Below are some additional important income tax return considerations for divorced or separated parents:
Tax Credit for Parents
You can claim certain tax credits for being a divorced parent, such as the Child Tax Credit or an Education Tax Credit. If you do not claim the dependent, you cannot claim an education credit even if you pay education bills. Even if your former spouse qualifies to claim your child as a dependent, you can still clam the Child and Dependent Care Tax Credit for expenses you incur to care for a child under age 13. Remember though, only the parent who claims the child as a dependent can claim the Child Tax Credit.
Asset Transfers and Taxes
Sometimes a divorce settlement will order the transfer of property from one spouse to another. If that happens, the beneficiary doesn’t pay tax on that transfer. Its important to note that the property’s tax basis will also shift. For example, if you receive property from your former spouse in the divorce and you later sell it, you will pay capital gains tax on the appreciation before as well as after the transfer. So you need to consider the tax basis as well as the value of the property when you are splitting up the property in a divorce settlement.
Retirement Assets Transfers and Taxes
During a divorce, it is important to carefully handle your retirement savings. If you decide to give your 401(k) money to your former spouse, the IRS may consider that a taxable distribution and you will be taxed on it. In order to avoid this, you should arrange for a transfer under qualified domestic relations order (QDRO) which allows your former spouse access to the 401 (k) funds you and will not be stuck paying tax.
Sale of a Home and Taxes
If you and your former spouse decide to sell your home when you get divorced, there may be capital gains tax impact on you. Usually, you can avoid tax on the first $250,000 of gains on the sale of your primary home if you have lived in it for two out of the past five years of ownership. If you sell property after your divorce and if the two provisions of own and live have been met, you and your former spouse can each exclude up to $250,000 of gains. If the sale happens after the divorce, then you may qualify for reduced exclusion even if the two-year tests have not been met. Also, if you receive the house in your divorce settlement and then sell it some years later, you can exclude up to $250,000. The amount of time that your former spouse owned the house will be added to your period of ownership under the two-year test.
Name Change After a Divorce
If you changed back to your previous last name as a result of a divorce or separation, you should notify the Social Security Administration (SSA) and report any changes made as soon as possible. When a tax return is e-filed, the name must match both the SSA and IRS records. A name mismatch can result in a return that is rejected by the IRS when it is e-filed. The return will then have to be paper filed which can result in a delayed refund. A qualified lawyer can help you with a name change filing with all appropriate state and federal governments.