Divorce brings many changes to the lives of families. It can also bring a number of financial planning opportunities. All should be discussed with both your tax professional and attorney and addressed in your divorce agreement. Today, we’ll discuss a few tax-specific topics to include in those crucial conversations.
It is always a good idea to revisit your payroll withholdings after any life change, especially after a divorce. The IRS has a tax withholding estimator on its website.
Tax Filing Status
Your tax filing status is reflective of your marital status as of the last day of the calendar year. If you were divorced at any time during the year, you will be filing as Single or possibly Head of Household. An individual who files as Head of Household is entitled to a higher standard deduction ($18,350 vs $12,200 for 2019) and sometimes lower tax rates than a Single individual. A taxpayer qualifies as Head of Household if:
- They were unmarried on the last day of the year, or married but the spouse was not a resident of the household for the last six months of the year
- Maintained a household by paying more than ½ of the cost of keeping up a home
- A qualifying individual lived with the taxpayer in the home for more than ½ of the year, even if the taxpayer waived the right to claim the individual as a dependent
When the home is owned by one party both before and after the divorce decree, generally, that party is entitled to all related itemized deductions. If the home is owned jointly, typically the related itemized deductions for the period that the property is owned jointly must be split between the parties.
Child Tax Credit
An individual may claim a Child Tax Credit ($2,000 per qualifying child in 2019 subject to income limitations) for a qualifying child under the age of 17 who can be claimed as the taxpayer’s dependent. Who can claim the qualifying child(ren) as a dependent, and possibly qualify for the Child Tax Credit, should be addressed in the divorce decree. If it is not, the custodial parent generally claims the child(ren) as a dependent. If the Divorce Decree states that the noncustodial parent is entitled to the Child Tax Credit in any given year, the Custodial parent must complete Form 8332 and both parents must attach the form to their tax return.
Child and Dependent Care Credit
An individual may claim the Child and Dependent Care Credit (maximum credit is $1,050 for one child and $2,100 for two or more children for 2019, subject to limitations) for a qualifying child under the age of 13 or who is disabled. Qualifying expenses pay for the care of the qualifying child, allowing the taxpayer to be gainfully employed. A divorced taxpayer may claim the credit even if they have released the right to claim the child as a dependent.
Other issues to consider upon divorce are:
- Splitting joint estimated tax payments made for the current year but prior to the divorce
- Taxing authorities handle this differently, some require a letter or special forms. Check with your tax advisor for the best way to handle this. Also don’t forget estimated tax payments are an asset that should be addressed in any property settlement agreements.
- Splitting overpayments from the prior year applied to the year of divorce
- These receivables, if applicable are assets that should be addressed in any property settlement agreements.
- Prior year outstanding joint tax liabilities
- These liabilities, if applicable, should be addressed in any property settlement agreements. Though taxpayers are generally joint and severally liable for joint tax liabilities, parties can agree to split the liabilities or to reimburse certain parties in their property settlement agreement.
Your divorce decree should address the parameters and amount of alimony in detail. For tax purposes:
- Alimony payments per divorce decrees executed or modified after 2018 are not includable in the gross income of the receiving party and not deductible by the paying party.
- Alimony payments per divorce decrees executed prior to 2019 are generally includable in the gross income of the receiving party and deductible by the paying party.
Child Support is neither includable in the gross income of the receiving party nor deductible by the paying party.
Tax Basis of Marital Property
When negotiating property settlement agreements, the tax basis of property included therein should be considered.
There are two marital assets worth $100 each. One has a tax basis of $100 and the other a tax basis of $25. The latter asset has an unrealized gain of $75 that may be taxed federally at a rate as high as 23.8% (plus state tax rates which vary). In this example one asset has a value after taxes of $100 while the other has an after-federal-tax value of $82.
We strongly recommend you work with a tax advisor and attorney to ensure any property settlement being negotiated considers the after-tax value of marital assets to avoid future surprise tax bills.
For tax years 2018 through 2025, nonbusiness legal expenses, which include legal fees related to divorce, are not tax deductible.
The Tax Warriors® at Drucker & Scaccetti work with attorneys and other trusted advisors in your life to help achieve what is best for your current and future life circumstances. If you need assistance navigating through the tax impact of divorce, call on us.