Decisions made in divorce can have a direct impact on your financial situation in the future. Importantly, there are many tax implications to consider when negotiating a settlement. From changing your filing status to dividing your marital assets and determining issues like alimony, parting ways with your spouse requires careful tax planning. It’s essential to consult with a knowledgeable tax advisor who can help you navigate these aspects of your divorce effectively.

Carefully Consider Your Tax Filing Status

If you and your spouse are considering parting ways, you should be mindful of the timing of your divorce to potentially benefit from significant tax savings. Under the IRS’s rules, your tax filing status is based on your marital status on December 31 of any given tax year. If you are divorced on the last day of the year, you can file as “single”, or even possibly “head of household”. However, if you are still legally married, even if divorce proceedings have commenced, you and your spouse may file a joint tax return. Alternatively, you could choose to file under the status, “married filing separately.”

Filing jointly has many advantages. It usually means you may qualify for certain tax breaks — and you may net a larger standard deduction. But under certain circumstances, it may be more beneficial to file separately, regardless of your marital status at the end of the year. For example, if you or your spouse had substantial medical expenses, filing separately can help you exceed the IRS’s threshold to qualify as a deduction.

Be Aware of the Tax Treatments for Alimony and Child Support

How alimony is treated depends on the date you were divorced. For divorces entered into as of January 1, 2019, alimony payments are not considered income by the receiving spouse or deductible by the paying spouse. This means that information about alimony does not need to be included on federal tax returns. However, if your divorce agreement was dated before January 1, 2019, alimony payments are deductible by the payor and must be reported as income by the recipient.

Similarly, child support is not deductible by the payor or classified as taxable income to the recipient. Neither the payor nor the recipient is required to include child support in their gross income.

Know Who Will Claim Your Child as a Dependent

It’s vital to understand the implications your children may have on your tax situation following your divorce. While claiming a dependent on your tax return can reduce your tax liability and help you qualify for certain tax credits, only one parent can claim a child as a dependent after divorce. Typically, the custodial parent has the right to claim the child — but this claim can be released to allow the non-custodial parent to claim the deduction by filing IRS Form 8332.

Understand What Triggers Capital Gains Taxes

When negotiating property division, it’s crucial to consider how long-term capital gains taxes can affect your financial situation. Although assets are transferred tax-free between spouses in divorce, capital gains taxes can be triggered by a subsequent sale of property awarded in a settlement.

Strategies to avoid, reduce, or defer capital gains can include:

• Transferring assets before the divorce is finalized
• Retaining assets until they are eligible for the lower long-term capital gains tax rate
• Using the primary residence capital gains exclusion
• Offsetting high gain assets with lower gain assets
• Considering structured buyouts or deferred sales

It’s important to work with a tax professional who can help you develop a strategy for dividing assets that may be subject to capital gains taxes.

Be Cautious When Handling Retirement Accounts

It’s critical to be cautious when handling retirement assets in divorce to avoid potential tax penalties. Certain types of retirement accounts require a Qualified Domestic Relations Order (QDRO) to divide the assets without incurring a tax penalty. Others can avoid tax consequences with a transfer incident to divorce.

IRAs and 401(k)s are typically not taxed when the transfer of assets is part of a divorce settlement. However, funds withdrawn directly from a retirement plan can be subject to income tax and a 10% early withdrawal penalty if the recipient is under 59½.

Contact an Experienced Tax Advisor

Divorce doesn’t only have emotional and legal implications — there are tax consequences to consider as well. If you are parting ways with your spouse, it’s imperative to work with a tax professional who can best advise you regarding your specific financial circumstances. Located in Fairfield, Connecticut, Rolleri & Sheppard CPAS, LLP offers strategic tax advice for divorce in Fairfield County. Contact us online or call (203) 259-CPAS to schedule a consultation.