My divorced tax clients are really good at navigating taxes with their former spouse. Impressively professional, even. There are just a few areas where divorce taxes are different, so we’ll cover them quickly here. As ever at AskFlossie, no shame, no shade. By the time people get there, divorce is almost always the right call.
Fortunately the IRS understands not everyone stays in a marriage, and the tax code is actually pretty well designed to help out newly single women. Special tax considerations occur only if you’re still connected to your spouse: through alimony / spousal maintenance, children you share, and community assets like a home, a retirement account, or pension.
Pro Tip: If you’re interviewing divorce lawyers and they cant answer any tax questions, move on.
1. Alimony Tax is Toast
One of the feminist changes in the 2017 Tax Bill was an overhaul to how alimony is taxed. Although legally spousal support has nothing to do with gender, 97% of people who receive alimony are women.
Before 2019, alimony or spousal support was deductible for the payer (e.g. dudes paying it got a nice tax break) and taxable for the receiver (e.g. the women who received it owed alimony tax).
The good news for divorced women: Now, if you receive alimony, you no longer have to count it as income. It is tax free. The bad news for divorced women: if you’re on the hook for spousal support, no more tax break. But girl, we give you a high five for being the breadwinner.
The sticky part of alimony: These changes apply to divorces or legal separations finalized January 1, 2019 or later. If you finalized before that, alimony is still taxable/deductible.
To be clear, the 2016 Republican congress was NOT secretly feminist. They made this change to collect more tax on on the same income. Alimony Payer = Higher Earner = Higher Tax Bracket. They just moved the tax burden from the lower-paying tax filer to the higher-paying tax filer. It was just a happy side-effect that it helped nearly 400,000 women.
2. Child Credits and Deductions are Negotiable
First, when it comes to divorce taxes, child support isn’t a tax thing. It’s not deductible for the payer, and the receiver doesn’t owe tax on it. So don’t worry about it.
You know what is a thing? Who declares the kids.
Declaring your kids can massively impact your finances, especially in lower tax brackets, because it comes with a lot of credits and deductions that can lower your tax burden:
- Child Tax Credit (Especially in 2021 – check out our post on the CTC updates)
- Child Care Tax Credit
- Earned Income Credit
- American Opportunity Credit
- Kids’ medical bills if your family medical expenses exceed 7.5% of Adjusted Gross Income.
By default, the credits and head of household status stay with the custodial parent, aka whoever has the most nights. However, who gets credits is negotiable.
- I’ve seen parents with equal custody alternate taking the tax credits – this year you, next year me.
- I’ve seen the credits land with the parent with full custody, who maximized them because she earned less, so the calculation was more favorable.
- I’ve seen them land with a noncustodial parent still supporting the whole family, because a tax break for him benefitted everyone.
Whether you want to and how you negotiate this part of your post-divorce taxes depends on your relationship with your ex. They’ll have to fill out Form 8332. If they are no longer in the picture, and you are raising the kids, I would declare as head of household and take all the credits you can get. A VITA tax site would be happy to help you.
3. Divorce Taxes and Home Ownership
What happened to the house you shared with your ex? WealthySingleMommy covers the scenarios in which you don’t sell the house. Not selling may be the right call for your family, and is simpler from a tax perspective. While selling offers a cleaner break, it might incur a capitals gains tax, especially if you bought the home recently.
To avoid capital gains on a primary residence, you and your Ex need to:
- File your taxes “married filing jointly” in the year you sell it off
- Together, you can write off $500,000 of capital gains
- Live in it, together for at least two out of five years before the sale. You do not need to live in it together right now, if you’ve got those two years covered.
- Remember, you can add any improvements to your cost basis, so keep those receipts!
If one of you ends up with the house, that person will be exempt from capital gains taxes on the first $250,000 in a sale. Only that person. Big difference! So if the house gained a lot in value and no one wants to live in it long term, it might be very advantageous to sell before your divorce finalizes.
4. Retirement Accounts, Pensions and Divorce Tax. Oh, my!
Yes, retirement accounts can definitely have major implications on divorce taxes. Depending on the laws in your state, your spouse may have a right to your retirement accounts, such as a 401(k) or Ira. And vice a versa!
These are usually hashed out in Settlement negotiations rather than tax time, but the details of your settlement might cause you to lose tax benefits that come with retirement contributions. Check in with your lawyer.
Pensions, however or different. Pension law requires that spouses have it confirmed right to distributions. When spouses divorce, the court will create a Qualified Domestic Relations Order (or a QDRO) and send it to the pension administrator to review and act on. Two salient points here:
- It’s possible for a spouse to waive their right to pension distributions when they marry someone with a pension or their spouse enrolls in a pension. Basically, if anyone asks you to notarize your spouse’s pension document, They may be asking you to waive your right to the distribution. Proceed with caution!
- The tax situation with spousal distributions of pensions can be a little complex, but tend to be favorable. I will circle back here and write another post soon. Meanwhile, if you’re in this obscure camp, do a little research before you finalize your settlement.
Come join our online community at AskFlossie so you can link up with other women figuring out divorce taxes and adjusting to newly single life. You can get answers to more financial questions from other women who’ve already been there.