Important Tax Considerations for Divorcing Couples
Getting divorced can be a stressful and complicated proceeding, especially when there are significant assets involved. There is a lot at stake with the division of marital property, and both spouses are going to want to receive their fair share. But the amount of property you receive is only a part of the equation, there are tax implications to consider as well.
If you are thinking about getting divorced in Virginia, the first step is to speak with an experienced family law attorney. At Buck, Toscano & Terezkerz, we can meet with you to go over your specific circumstances and discuss important issues like the division of assets and taxes. It might also be beneficial for you to speak with your financial planner or tax professional to go over more complex tax situations.
Tax Issues for Divorcing Spouses to Be Aware Of
There are a number of potential tax implications that divorcing couples should be mindful of, here are some of the most common:
- Tax Filing Status Changes
Couples need to be aware that their tax filing status is likely to change when their divorce is finalized. For example, if your status while married was “married filing jointly”, it would change to “single” or “head of household” in the next tax year.
It is important to note that the appropriate tax filing status is determined by your marital status as of the last day of the tax year, which is typically December 31. If you encounter a situation in which your divorce does not get finalized until early in the New Year, then you will need to decide whether you should continue filing a joint return with your spouse or filing on your own as “married filing separately”.
It might be better financially for both spouses to file jointly one last time, but this may not be the best option depending on your specific situation. For example, if your relationship is severely strained, then you might not want to attach your name to your ex-spouse and be responsible for their taxes as well as your own. These are issues to discuss with your attorney and/or tax professional.
- Deciding Who Receives Child Tax Credits
The annual Child Tax Credit (CTC) is a significant benefit that the government allows for lower and middle income families. The CTC is fully refundable, and for 2021, it can be as high as $3600 per child. Only one parent can claim this credit during any given tax year, however, so you will need to decide which parent receives the benefit.
If one parent has sole physical custody of the child, is often assumed that this would be the parent who receives the credit. However, there are times when it makes sense for the noncustodial parent to claim it, and some couples choose to alternate back and forth each tax year.
- Determining the Best Way to Handle Property Transfers
In general, property transfers between spouses (or to ex-spouses pursuant to a divorce) are considered nontaxable events. However, the sale of certain property could result in tax consequences. Selling a principal residence is normally excluded from capital gains up to $500,000 for married couples, but if you are selling a second property (e.g., vacation home or rental) or stocks that have gained in value since you bought them, then these sales may be taxable.
- Tax Implications of Dividing a Business during a Divorce
The way you choose to deal with a business that is owned by one or both spouses could trigger a taxable event when you get divorced. When divorcing couples have a business to divide, there are generally three options:
- One spouse buys out the other.
- The spouses decide to continue co-owning the business.
- The couple sells the business to an outside party.
In the first two scenarios, there will usually not be any tax consequences, although with the first scenario that would depend on how the couple structures the buyout. But in scenario three where you are selling the business, this could definitely end up being a taxable event.
- Division of Retirement Assets
Retirement accounts can be transferred during a divorce without tax consequences as long as the transfer is structured properly. For example, when dividing a 401(k) account, a court must issue a qualified domestic relations order (QDRO). IRAs are not governed by a QDRO, but they can still be transferred to a spouse tax free as long as the parties follow IRS guidelines.
- Determining the Best Way to Deal with Alimony/Spousal Support Payments
Under federal legislation that was passed and signed into law in 2017, alimony payments are no longer tax deductible for the payor spouse and no longer taxable income for the recipient spouse starting with divorces that were finalized after December 31, 2018. Because paying spouses cannot take this deduction anymore, they are often more resistant to the idea of paying alimony/spousal support.
If this situation applies to you, this is another issue that you should speak with your divorce attorney about. There could be other more creative ways to handle spousal support that might be a good fit for your circumstances. For example, the recipient spouse could simply receive more of the marital property in lieu of a lump sum alimony payment. Or you might want to ask your attorney about an alimony trust and whether that might be a good solution in your case.