From dividing your assets to reducing your household income, divorce can have a significant impact on your economic situation. While it’s essential to take proactive financial steps to plan for the next chapter in your life, it’s also crucial to avoid pitfalls. Here are some of the top mistakes to avoid in your post-divorce financial and tax planning:
1. Not Planning Around Your New Budget
When you divorce, your income, expenses, and lifestyle will change. It’s vital to create a new budget that reflects your post-divorce financial situation. Reevaluate your priorities, consider your short-term and long-term goals — and be prepared for any one-off expenses that may arise. Failing to plan a new budget can lead to pitfalls and negatively impact your long-term financial security.
2. Failing to Update Your Tax Filing Status
A common mistake people make when they begin the divorce process is assuming their tax filing status is “single.” However, it’s important to understand that your filing status is based on your marital status as of December 31 of the tax year. If you are legally divorced at the end of the year, you must file as single for that tax year. Regardless of whether the divorce process has been commenced, the IRS considers you to be married until the final decree is issued.
If you’re legally married at the end of the tax year, you can choose to file one of the following statuses:
- Married filing jointly
- Married filing separately
- Head of household – but only under certain conditions – Consult your CPA
Filing under the wrong tax status can result in incorrect tax liability, loss of specific tax benefits, and raise red flags with the IRS. It’s best to consult with an experienced tax professional who can advise you regarding the filing status that is right for your situation.
3. Forgetting to Adjust Tax Withholding
After divorce, your new income level may require different tax withholding from your paycheck. Failure to make the necessary changes can lead to an unexpectedly large tax bill. It’s important to submit a new W-4 to your employer as soon as possible following the finalization of your divorce.
4. Failing to Reassess Your Retirement Plan Contributions
If your retirement plan was divided in divorce, you may need to reassess your contributions to ensure you get back on track. Revisit your strategy and increase your contributions if possible. You may also need to rethink your age for retirement and restructure your plan for tax optimization. A knowledgeable tax professional can help you develop an investment strategy that will meet your financial objectives and minimize your tax liability.
5. Not Building an Emergency Fund & True Ups
One of the biggest mistakes to avoid in post-divorce financial planning is failing to build an emergency fund. No matter how tight your budget may be, put aside some money from each paycheck to ensure you can cover expenses in the event of an emergency. Aim to have three to six months of expenses saved, separate from your primary checking and savings accounts. Accounting for income taxes is also a critical component.
Another item to avoid is not doing the annual true-up reconciliations on alimony/child support. 99 out of 100 cases generally results in a required payment due to or from a divorced spouse. I highly recommend this be performed to ensure accuracy and accountability During the alimony/child support tenure.
Contact an Experienced Tax Professional
If you are going through a divorce, it’s important to have an experienced tax professional by your side to help reduce the potential tax impact and protect your financial interests. Based in Fairfield, Connecticut, Rolleri & Sheppard CPAS, LLP offers a wide range of financial and accounting services for individuals facing divorce and assists them in making informed financial decisions as they go through the process. Contact us online or call (203) 259-CPAS to schedule a consultation.
