Divorce involves challenging personal matters, and taxes are likely the last thing on your mind. However, it's important to address several tax considerations to minimize your tax burden and make informed decisions. Here are six key tax issues to be aware of during a divorce.
1. Personal Residence Sale
When a divorcing couple sells their home, they can usually avoid taxes on up to $500,000 of the profit if they've lived in the home for at least two of the past five years. If one spouse continues to live in the home while the other moves out but they both still own it, they may still be able to avoid taxes on up to $250,000 each when the home is sold later. To ensure this, specific language might need to be included in their divorce agreement. If they haven't met the two-year requirement, they might still qualify for a partial tax exclusion due to unforeseen circumstances.
2. Pension Benefits
In a divorce, a spouse's pension benefits are often included in the property settlement. The preferred way to handle these benefits is through a "qualified domestic relations order" (QDRO). This order allows one ex-spouse to share in the pension benefits of the other and ensures that the receiving ex-spouse is taxed on those benefits. Without a QDRO, the ex-spouse who earned the benefits will be taxed on them, even if they are paid to the other ex-spouse.
3. Filing Status
If you are still married at the end of the year but are in the process of getting divorced, you are still considered married for tax purposes. We can assist you in deciding whether to file your 2024 tax return as married filing jointly or married filing separately. Some separated individuals might qualify for "head of household" status if they meet certain criteria.
4. Alimony/Support Payments
For divorce or separation agreements executed after 2018, there is no deduction for alimony and separation support payments made by the paying spouse, and the receiving spouse does not include these payments in their gross income. This change was part of the Tax Cuts and Jobs Act. Unlike some temporary provisions of the law, the repeal of the alimony and support payment deduction is permanent. The rules are different for agreements made before 2019.
5. Child Support & Child-Related Tax Return Filing
Regardless of when the divorce or separation agreement was executed, child support payments are not deductible for the paying ex-spouse and are not taxable for the receiving ex-spouse. Additionally, you and your ex-spouse will need to decide who will claim your child or children on your tax returns to benefit from related tax breaks.
6. Business Interests
When business interests are transferred during a divorce, it's important to ensure that "tax attributes" are not lost. For example, transferring interests in S corporations might result in "suspended" losses (losses carried forward to future years) being forfeited. Similarly, transferring a partnership interest can bring up complex issues related to partners' shares of partnership debt, capital accounts, built-in gains on contributed property, and other intricate matters. Careful consideration is needed to navigate these tax implications properly.
These are just some of the issues you may face during a divorce. You might also need to adjust your income tax withholding and notify the IRS of any new address or name change. Additionally, there are estate planning considerations to keep in mind. We can assist you with navigating the financial complexities of divorce.