If your divorce was not taxed enough already …
Consider These 7 Critical Tax Problems Before and After Divorce
“In this world, nothing is certain except death and taxes.” – Benjamin Franklin, 1789
We have all heard it. Some of us even said it. This famous adage has been repeated over and over again through the centuries as a fatalistic observation that describes something both inevitable and inevitable.
While the concept of death seems simple enough, the passage of time has proven that taxes keep getting more and more complicated. Taxes are a complicated concept for many, even at a basic level. For anyone facing the prospect of a divorce (which can look like a death), taxes will certainly be even more confusing.
To help clarify some of the tax issues associated with a divorce, there are several things to consider before and after finalizing your divorce.
Main tax considerations before finalizing your divorce:
1. Consider the tax implications of child support and alimony – Child support and alimony could be the most controversial issue in any divorce. It can be difficult to find the right balance between ability to pay, marital standard of living, the lifestyle needs of each spouse and, ultimately, the childcare schedule. Each has a great effect on the bottom line.
There has been a big change in the tax legislation around child support thanks to the Tax Cuts and Employment Act 2017. While child support is not tax deductible for the spouse who payroll and is not taxed by the spouse who receives it, alimony payments are no longer tax deductible for the payer or taxed as income for the recipient. This new tax treatment strongly influences the amount of support ordered by the courts and the level of support considered “reasonable” during mediation or settlements. If you have been paying child support for many years and your divorce was granted before 2019, you benefit from “grandfather” under the old rules – you will still deduct the payment from your income tax return and your ex-spouse will continue. to pay tax on it. payment as income.
If you have consolidated your alimony and child support as “family alimony” in your agreement, it will be fully taxable for the recipient and deductible for the payor, just like the alimony. The court order does not specify the portion of the child or spousal support order. This is a very significant difference when you compare support to child support – child support is deductible for state tax purposes and child support is not. not. Divorces concluded before 2019 benefit from acquired rights under the old rules.
2. Determine the best way to transfer ownership – When couples divorce, property transfers between the two parties generally occur without tax consequences on either side. However, it may be wise to forgo the tax exemption the law grants divorced spouses for transfers of property and intentionally create a taxable event by structuring the transaction as a “real sale” more than a year later. the finalization of the divorce. This could allow the spouse who purchases their ex-spouse’s share of the family residence to benefit from a higher base cost on the property.
Example: Suppose a couple in California bought a house for $ 1,000,000 and five years later they divorce and the house is now worth $ 1,300,000. If they have a mortgage on the property for $ 700,000, the home equity would be around $ 600,000. At this point, “Primary residence tax – she would have to pay federal and state taxes on the remaining $ 50,000 of earnings, which would cost her approximately $ 16,700 (assuming a federal capital gains tax of 20% and a California state tax of 13.3%). If the wife wants to stay in the house and takes this asset on her balance sheet, then she will have to give her (soon) other assets totaling $ 583,300 to her ex-husband.
But what if you structured this property swap as a purchase instead? The wife could “buy” the house from the community and both parties could benefit from the tax savings. If the community were to “sell” to the wife, then the capital gain exclusions of both spouses would be in play. Not only would no tax be due on the “sale” of the house, but the “new” base cost. of the house for the wife would be $ 1,300,000, thus reducing her potential capital gains tax in the future.
Before taking advantage of the tax relief suggested in this example, you should consult your CPA and / or lawyers. Resetting the tax base also means resetting the property tax base. While the wife may save money on capital gains tax over the last few years once she finally sells the house, the annual property tax bill will likely increase based on the new price of. sale.
3. Make sure you manage retirement accounts with care – In order to transfer all or part of a qualified pension plan as part of a divorce settlement, a court must issue a qualified family relations order (QDRO). There are no tax consequences if the transfer is properly structured as a qualifying rollover distribution. When receiving part of a former spouse’s retirement account as part of a QDRO, the beneficiary must decide whether to keep it in the existing plan or whether to transfer the funds to an IRA. QDROs do not govern the division and transfer of IRA assets. However, it is very easy to transfer IRA dollars using a (direct) trustee to trustee transfer with no tax consequences – you simply open an IRA for the benefit of the other spouse and provide a copy of the divorce decree. the custodian (the bank that maintains the accounts). To be exempt from taxes and early withdrawal penalties, these transfers must be processed in accordance with IRS regulations.
4. Know who is claiming the children as tax credits – Only one spouse can claim the children as post-divorce tax credits, so determine which spouse would benefit the most from this deduction and then seek to share the profit. More often than not, it is the parent who spends the most time with the children who reports the children on their tax return as dependents. If you instead allow the parent with the highest adjusted gross income (who earns the most money after deductions) to claim this tax credit, more money will be saved instead of being spent on taxes.
Main tax considerations after finalizing your divorce:
1. Another word on claiming children as tax credits – The first spouse to file their income tax return will be able to claim the children, and the burden of proof regarding the right to claim them falls on the second filer. If you’re worried that your ex is trying to claim the “dependent deduction” you are actually entitled to, be sure to report early so you don’t fight for your right to that deduction with the IRS. Trying to fix the issues with your tax return through the IRS might be the only thing worse than fixing all the issues with your ex during your divorce.
2. Ask the head of the household if you have a child – If you are considered single on the last day of the year (whether you are divorced or legally separated), you can benefit from a higher standard deduction by claiming Head of the family. You can claim the status of head of the family if you have custody of your children for more than half of the year ….even if your ex-spouse already declares the children as dependents on his income tax return. Under the new tax law, the standard deduction is $ 18,000 for the head of the family, compared to $ 12,000 for the status of sole filer.
3. Know that you could still be audited – Just because your previous years tax returns are filed and already forgotten, remember that you and your ex could still be audited together on those joint tax returns that were filed up to three years ago. Be prepared to cooperate and do your part to provide information or documents to support the numbers you have filed with the IRS.
It is safe to say that even the Founding Fathers of our nation could not have foreseen the complexities of our current tax system. Yet Benjamin Franklin was prescient enough to recognize the certainty of taxes. Knowing that taxes can and will undoubtedly play an important role in a divorce, it is best to hire a professional to help you plan for the best possible outcome.
The information contained in this document is not personalized. You should not assume that any discussion or information contained in this document serves as a receipt or substitute for personalized investment advice.