Your income taxes can be affected in many ways by your divorce. Although income tax rules can differ by state, the following breakdown should help prepare you for how divorce may impact your federal taxes:
- After your divorce is final, you will no longer be filing as a married couple but more likely as a single. Be sure you are aware of what you are withholding for federal taxes from any employment income and if you will need to make estimated quarterly payments towards your yearly taxes.
- Alimony payments are tax-deductible by the paying spouse, but child support is not. If you are the receiving spouse, spousal support payments are taxable provided they qualify as “alimony” under tax rules. Since child support isn’t deductible by the paying spouse, it also isn’t taxable to the recipient. You are also entitled to claim a dependency exemption if you have legal custody of the child(ren). However, you also have the right to waive this exemption and allow the non-custodial spouse to claim it.
- When property is divided, the tax effects are not immediate. Property transferred between the spouses does not result in a taxable gain or loss to the transferring spouse. However, the receiving spouse will take the same basis (cost) in the property that the transferring spouse had. It is possible that at a later date the receiving spouse may have to pay taxes, if and when the property is sold. So when dividing assets, it is important to take into account the cost basis as well as the property value. There are special tax rules that may apply to the transfer of the marital homeif the property is sold within two years, so tax planning is important.
- How you handle your retirement plans, such as an Individual Retirement Account (IRA) or a 401(k), can have significant tax implications. A direct transfer to the receiving spouse’s IRA or 401(k) is usually preferable. If there is equity in a closely held business transferred from one party to another due to the divorce, it is highly important to ensure certain tax attributes are not forfeited.
- It can get even more complicated if you and your spouse live in different states given that divorce laws vary from state to state. States use different formulas to calculate child and spousal support. Some states consider marital property to be community property, while others consider it equitable distribution. It is best to speak with an attorney to discuss the benefits of filing divorce in either state.
As always, it is important to get advice from professionals when moving through this personal and financial transition.
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Loretta Hutchinson CFP®, CDFA™ is a Certified Financial Planner and President of Financial Divorce Plan, LLC. She can be reached at Loretta@FinancialDivorcePlan.com , or 267-202-5158.