Tax Planning in Divorce

Tax Implications of Support Obligations

When filing a tax return, it is required by federal law to report all income earned. It is important to note that child support payments are not considered taxable income for the parent receiving the payments nor can they be deducted from the gross income of the parent making the payments, regardless of the number of children covered under the support obligation. In contrast, spousal support payments have historically been viewed as taxable income for the party receiving support and deductible from gross income for the party making the payments. However, changes in the federal tax law state that spousal support payments made after a divorce finalized in 2018 or later will not be considered taxable income for the recipient nor deductible from the gross income of the payor.

Filing Tax Returns during Divorce

When divorcing, it is not possible to file a joint tax return for the year. Therefore, during tax planning, it is crucial to determine whether to file taxes jointly or separately. If you file separately, you will be solely responsible for your individual tax obligations to the IRS, without sharing the responsibility for your estranged spouse's tax obligations. Nevertheless, filing separately may lead to a higher tax rate and prevent you from claiming specific deductions.

It is also vital to establish who can claim a child as a dependent on their tax return if you and your spouse have a child. If no court order specifies who can claim the child, and you cannot agree, typically the parent with physical custody of the child for the majority of the time can claim the child.

Tax Implications of the Distributions of Marital Assets

When divorcing couples jointly own property, such as real estate, there are generally no tax consequences if one spouse transfers the property to the other pursuant to their divorce agreement. However, if the marital home is going to be sold, it may be more advantageous to do so before the divorce is finalized, as most married couples are eligible for a greater capital gains exclusion than single individuals.

The taxation of retirement funds from a 401K or pension that are being divided between divorcing spouses depends on the manner in which they are distributed. It is important in most cases to have a qualified domestic relations order to define each party's tax obligations and prevent any need to pay taxes in connection with the division of the retirement plan.