Getting divorced often entails untangling knotty financial issues, both before and after the marriage officially comes to an end. In a survey from the American Institute of Certified Public Accountants, 57% of CPAs polled said that understanding the tax implications of a permanent marital split can help men and women better prepare financially for their post-divorce life.
When it comes to filing taxes as a divorced person, there are certain issues that you may find yourself dealing with from year to year, particularly if you have children. As tax season draws to a close, there are several important considerations for divorced couples to keep in mind as they prepare their returns. (See: Taxing Times for Divorced Parents.)
7 Tax Traps to Watch Out for After Divorce
There are a number of tax breaks you may be able to take advantage of if you have children. Deciding who gets to claim those benefits can be tricky when you and your child’s (or children’s) other parent are divorced. Deciding who gets what as part of the divorce settlement can also be problematic if it triggers tax penalties. With that in mind, here are some of the most common tax issues you may encounter after a divorce.
1. Child-related Exemptions
First, you must decide who gets to claim an exemption if the child has dependent status. To qualify as a dependent, a child must be under age 19 at the end of the year or under age 24 if he or she is enrolled in school, has lived with you for at least half the year and has provided no more than half of his/her own support.
Generally, the custodial parent would be able to claim an exemption for any qualifying children from the marriage. The Internal Revenue Service (IRS) does, however, allow divorced parents to alternate back and forth, essentially taking turns claiming the exemption. For 2017, the personal exemption amount remains the same as it was in 2016: $4,050. Just remember that for single filers, the exemption begins to phase out once your adjusted gross income (AGI) reaches $259,400. The income phase-out threshold increases to $285,350 for those filing as head of household.
2. Child Tax Credit
Next, there’s the child tax credit. This is a nonrefundable credit worth up to $1,000 for each qualifying child you claim on your return. To qualify, your child must have dependent status and be under age 17. This credit, which can reduce your tax liability on a dollar-for-dollar basis, also has a phase-out limit. Once you hit $75,000 in adjusted gross income as a single filer, the amount of the credit you can claim begins to be reduced.
3. Tax Credit for Childcare and Dependent Care
One of the most challenging aspects of being a single parent is covering the cost of childcare while you work. The child and dependent care credit is designed to offset some of the expense and it’s worth up to $3,000 for one qualifying child or up to $6,000 for two or more qualifying children. One thing that divorced couples should keep in mind is that the custodial parent may be able to claim the child and dependent care credit, even if the noncustodial parent is claiming the child for exemption purposes.
4. Child Support and Alimony Payments
If child support is part of your divorce decree, there are no tax advantages – or penalties – associated with those payments. While alimony is tax deductible for the person paying it and considered to be taxable income for the person receiving it, those same rules don’t apply to child support, regardless of the amount. If you receive child support payments, you don’t have to report them on your income tax return. One plus of receiving alimony is that you can use the money to fund an individual retirement account (IRA).
5. Gains and Losses for the Sale of Real Estate
If you owned real estate or other assets together and these were sold as a condition of your divorce settlement, there are additional tax rules that you need to be aware of. Generally, there’s no recognized gain or loss when property is transferred between former spouses if the transfer is the result of a divorce. You may, however, have to report the transfer on a gift tax return.
If you sell a home that you and your spouse owned together, you each have to report your share of any gains or losses on your tax return for the year when the sale occurred. If the home was your primary residence, you may be able to exclude up to $250,000 of gains on the sale. You had to have owned the home for at least two years to qualify for the exclusion.
6. Transfer of Tax-advantaged Savings Accounts
Transfers of health savings accounts (HSAs) or IRAs through divorce also don’t trigger taxable events. Once the transfer is complete, however, that account would be considered the asset of the person who received it, meaning he or she would be responsible for any taxes owed on distributions moving forward.
7. Deductibility of Legal Fees
Unfortunately, you can’t deduct any legal fees or court costs you paid to get a divorce. You may, however, be able to deduct fees paid to a tax advisor or attorney as part of a bid to secure alimony payments. To deduct these fees, you have to itemize on Schedule A and claim them as miscellaneous itemized deductions, subject to the 2% of AGI limit.
The Bottom Line
Getting divorced is stressful enough, and when tax filing issues crop up, that can only add to your anxiety. Knowing the obstacles you may encounter when preparing your return can make the process much smoother. If you have a particularly complicated settlement, seeking advice from a tax professional may be necessary to ensure that you’re filing your return correctly and taking advantage of all the various tax breaks you’re entitled to. (See also: 5 Financial Mistakes to Avoid During a Divorce.)