The Implications of Divorce and Taxes

How to improve your experience during your divorce

I’m nonetheless here today to help provide to you some tips on how to improve your experience in the divorce process. Today’s episode details the implications of divorce on taxes. For those just starting off in the divorce process, it is important to be aware of the longterm financial implications that divorce can create, especially as it relates to taxes.

Before we start, please consult a financial expert before making long term financial decisions. It’s going to get technical today folks, so buckle up. Starting us off, number five.

It lowers the standard of living of both parties

From a financial perspective, getting a divorce lowers the standard of living of two individuals who are often joined in a dual income union. Many times neither can afford the living arrangements of their previous life and are forced to downgrade. When they go about selling the marital home, they do not consider the tax implications on the sale. The tax levied on the profit of the sale of the marital home is called the capital gains tax. A Supreme Court decision resulted in the transfer of appreciated property in exchange for the release in marital rights, which then resulted in the recognition of gains to the transferrer according to the American Bar Association.

This resulted in the creation of Internal Revenue Code 1041, which states that no gain or loss is recognized on a transfer of property from a spouse or former spouse to a spouse or former spouse if the transfer is incident to the divorce. Basically, if a husband were to give the wife the marital home during the divorce or the home was awarded to one party over another, no money would be exchanged in the transaction.

The liabilities of the property transfer or to which the property is subject exceeding the adjusted tax basis on the property itself under Internal Revenue Code 1041 create the tax consequences when transferring properties. One of the main consequences is in regards to the family’s home’s sale, which allows qualifying tax payers to exclude from gross income gain up to $250,000 or $500,000 for qualifying joint filers according to the American Bar Association.

Typically, the filing status for most couples is determined on the last day of the year. If you were married on December 31, then you file as married filing jointly and still be entitled to the advantages like exclusion limits for capital gain on the sale of principal residence. It is important to note that since you’ll be filing jointly, you’ll both be liable if you were audited.

There are tax related consequences to having to withdraw funds from your 401k account in order to pay an ex spouse according to family law attorney Richard J. Coffey. There is an early withdrawal penalty that is considered taxable income, however, the penalty is dodgeable if you fill out a qualified domestic relations order. The degree that a divorce will impact your retirement is dependent on the duration of your marriage, the types of retirement benefits involved, your spouse’s retirement accounts, and the laws in your state. As much as it may be difficult to cut into part of your retirement and your financial future, it is a necessary evil to acquire funds quickly.

Who gets tax benefits of the child?

Generally speaking, the custodial parent gets to claim all of the child related tax benefits for a child, including the Child Tax Credit, the dependency exemption, the Child and Dependent Care Credit, the exclusion for dependent care benefits, head of household filing status, and the Earned Income Tax Credit according to the Internal Revenue Services of the United States Department of Treasury. There is an exception, which applies to divorced or separated parents or parents who have lived apart for the last six months of the calendar year. It states that non custodial parents may claim the dependency exemption for a child if the custodial parent releases the exemption. Additionally, the non custodial parent can claim the Child Tax Credit if the other requirements for the Child Tax Credit are met, but only the custodial parent can claim the dependency care credit.

Alimony is tax deductible by the payer. It must be reported as income by the recipient according to the IRS. It is also considered an above the line deduction so it can be subtracted from your gross income before you reach your adjusted gross income. According to family law attorney and CPA Joe Cordell, there are four circumstances under which alimony can be deducted. Number one, the payments are made pursuant to a written agreement or judgment. Number two, you are not a member of the same household. Number three, the payments are not child support, which is determined partially by a three year payment analysis.

Number four, payments end upon your ex spouse’s death. Deducting alimony also requires you to understand the three year recapture rule, which is the ability to require you to claim all of the previous deductions within that period. It also implies that the recipient is entitled to the reduced reported income from the alimony payments previously received. This rule is applicable when the payments decrease or terminate during the first three post divorce calendar years and the total payments made in the third year decrease by $15,000 or more from the payments made in the second year, or the payments made in the second and third years are substantially less than the payments made in the first year.