When you're going through a divorce, taxes may not be your first concern. However, your tax situation can change drastically during and after a divorce. Here are some of the most common tax situations that may be impacted during and after a divorce.
- After a divorce, it's not uncommon for someone's tax situation to change drastically.
- Depending on whether you are divorced or only separated on or before Dec. 31, you may have options in terms of your tax filing status.
- A number of child tax credits are available for parents; who gets them depends on which parent is the custodial parent in the divorce.
- Pay attention to the timing of the sale of your home, one of the largest assets most couples possess, in order to benefit from a higher exemption.
- Alimony payments are no longer deductible by the payer and are therefore not included in income by the recipient.
What Is Your Filing Status?
Depending on where you are in the divorce process as of Dec. 31, you may have options when selecting your filing status.
Separated at year end but not yet divorced
There are limited circumstances under which you may qualify as head of household (HOH) despite not being legally divorced.
MFJ is almost always more beneficial, as it gives you greater access to tax credits that are not available if you file MFS. In 2021, the standard deduction for MFJ was exactly double the standard deduction for MFS. Married filing separately is usually not beneficial (with a few limited exceptions) from a purely financial perspective. However, it may be a good option for those who wish to separate their finances as soon as possible.
Divorced at year end
- You are considered unmarried at year end according to the Internal Revenue Service (IRS). To be "considered unmarried" while still technically married, your spouse must not have lived in your home the final six months of the year, and you need to file separate returns in addition to the other criteria listed here.
- You have a qualifying person who lived in your home for more than half of the year (certain exceptions to this requirement exist for children away at school and dependent parents who are in your care).
- You must have paid more than half the cost of keeping up your home for the year.
There are many benefits to filing HOH. The standard deduction is higher for HOH than it is for a single filer. HOH allows you to qualify for certain tax credits (explained in more detail in the next section). In addition, the lower tax brackets have higher income limits for head of household than for single filers, which means effective tax rates for HOH filers are also lower.
If the qualifying person is your child, you can only file as HOH if you are the custodial parent. The custodial parent is the one the child lives with for the greater number of nights of the year. If you have 50/50 custody of your child, the custodial parent is the one with the higher adjusted gross income (AGI), according to the IRS.
Children of Divorced Taxpayers
There are many tax issues that arise when you and a former spouse share children together. As explained in the previous section, a noncustodial parent cannot claim head of household (HOH) status. Additionally, a noncustodial parent cannot claim their child for the purposes of the earned income tax credit (EIC), the American Opportunity Tax Credit (AOTC), or the child and dependent care credit.
The child tax credit is one that usually defaults to the custodial parent. However, a noncustodial parent may claim their child as a dependent and receive this credit if the custodial parent signs IRS Form 8332, releasing the right to claim the child as a dependent. In recent years, the credit has amounted to $2,000 per qualifying child. For 2021, as a result of the American Rescue Plan, the child tax credit has been increased to $3,000 for children ages 6 to 17 and $3,600 for children under age 6.
Child support payments are not deductible by the payer, and they are not included in the recipient's taxable income.
Medical expenses for the child that the noncustodial parent pays can still be included in their medical expense deduction, even if the custodial parent claims the child as a dependent. Both parents are eligible to claim any medical expenses actually paid by them for the child.
Alimony and Spousal Payments
Alimony was taxed differently prior to the Tax Cuts and Jobs Act. For divorces that were finalized by Dec. 31, 2018, alimony payments were deducted from taxable income by the payer and included in income by the recipient. For divorces finalized after Dec. 31, 2018, alimony payments are no longer deductible by the payer and are therefore not included in income by the recipient. This new treatment is similar to the treatment of child support payments.
Asset Transfers and Divisions
When you divorce, there is bound to be a transfer or division of assets between the spouses.
Sale of a primary home
The biggest item most spouses have to divide is the family home. If you sell your home as a result of your divorce, there are several things to keep in mind. If you sell your home prior to divorce while you're still filing taxes jointly, you can be exempt from up to a $500,000 gain on the sale of the home. This exemption is only for the primary home that you have lived in for at least two of the past five years.
Individually, each spouse is exempt from $250,000 of gain on the sale of a primary home. Therefore, if you are the sole owner of the house after the divorce and you subsequently sell the home, you will be limited in your exemption to a gain of $250,000. If you and your ex-spouse co-own the home after the divorce, and you sell the home subsequently, you will each be entitled to a $250,000 exemption on any gain.
Retirement accounts transfers
Your divorce agreement may require you to split your retirement savings with your ex-spouse. Cashing out your retirement account to pay your spouse at the time of your divorce would cause a taxable situation. Thankfully, the IRS allows a qualified domestic relations order (QDRO) to limit the tax burden in this situation. A QDRO is a legal document, typically found in a divorce agreement, that recognizes that a spouse, former spouse, child, or other dependent is entitled to receive a predefined portion of the other spouse's individual retirement plan assets.
Update Your W-4 at Work
When you have a change in circumstances, such as a divorce, or a marriage, or a new baby, it is always a good idea to take a look at your W-4 at work. Your W-4 determines your payroll withholdings and federal tax payments. Be sure to file a new one with your HR department that takes into account your new marital status.
My Spouse and I Are Legally Separated, but not Divorced. What Is My Filing Status?
If you are legally separated, the IRS considers you to be single for tax-filing purposes. Otherwise, your status is married filing jointly, married filing separately, or head of household, depending on the circumstances.
Who Is Responsible for Taxes, Interest, or Penalties Due to the IRS in a Divorce?
If you and your ex-spouse filed jointly when married, you are both equally responsible for any IRS debt. This is true even if your divorce decree says your former spouse is responsible for any amounts due on previously filed joint returns. However, the IRS offers relief under certain circumstances.
Can I Claim Head of Household Filing Status After a Divorce?
In order to claim head of household (rather than single) status, you must meet certain qualifications. The best way to determine if you qualify is to use IRS Form 886-H-HOH which lays out all the documentation you need to claim head of household status. Make sure you qualify before filing.
The Bottom Line
Divorce has the potential to significantly impact your tax situation. Divorce laws vary considerably by state, so be sure to research any state-specific tax issues that might arise from your divorce. This gives a brief overview of some of the most common tax situations that arise during a divorce. It is always beneficial to consult with a tax attorney or certified public accountant (CPA) to discuss any issues that are specific to your own tax situation.