Of all the things going through your mind when undergoing a divorce, the tax law is probably not high in the list. But once the dust settles, it is important to take a few moments to review the ways that a divorce can affect taxes for the former spouses. The IRS publishes a pamphlet for people in this situation, Publication 504. Here are some highlights:
Filing status. As far as the IRS is concerned, your filing status is based on the last day of the tax year. If you get divorced at any point during the year, then the proper filing status is “single” for that tax year. Of course, if you remarried within that same year, then you are married again as far as the IRS is concerned. In addition, if you got divorced only for the purpose of filing tax returns, and intend to get married again to the same person next year, then you are “married” as far as the IRS is concerned, even if you are legally divorced under state law.
Dependents. A big issue for divorcing couples to ensure that they resolve any question about who will be able to claim children as dependents for tax purposes. This is normally outside the control of the parents because of what the IRS calls the residence test. A taxpayer can only claim a dependent child for tax purposes if the child lived with that parent for more than half the year. But in the year in which a divorce happens, it is theoretically possible that both parents could meet the residency test.
If both parents plus a child lived together for six months, and then the parents got divorced and divided the remaining months equally, both parents would have nine months of residency. In that case, a declaration by one parent that they will waive the right to claim the child as a qualifying child will clear the way for the other. If both parents want to claim the child, the IRS will examine the number of days that the child lived with each and will allow the one with more time with the child to claim the child. If both parents had exactly the same number of days living with the child, the IRS will let the parent with the higher adjusted gross income claim the child for dependency purposes.
Alimony. Alimony is taxable income for the recipient and deductible for the person making the payment. This fact can and should play a role in deciding about alimony and child support during the divorce proceedings. Child support is not taxable income, and cannot be deducted by the payer.
Property settlement. In general, when divorcing couples divide their property as part of the settlement the divvying up of property is not income. The rules get more complicated if an item has to be sold in order to divide it (such as a house or collectibles), in which case the gain on the sale will have to be reported. But because the rules about who is entitled to the proceeds of the sale will vary from state to state, there is no simple answer for tax purposes.
An accountant will likely be needed to help divide the gains from the sale. If the ownership of property is transferred between spouses without a sale, then the acquiring spouse also acquires the other spouse’s basis in the property, and that will impact the gain realized at a later date. It would be helpful to work that out before the divorce is final, so as to avoid having to track down an ex-spouse years after the fact.
Legal fees. The costs of getting a divorce, such as attorney’s fees, are not deductible. But the legal fees incurred in trying to get alimony are deductible and so are fees paid for tax advice. If your divorce lawyer is helping to get alimony, or is also involved in giving you tax advice, ask for a detailed breakdown of services and deduct the part of your legal fees that involve alimony and tax advice.
Looking forward. Beyond the divorce itself, becoming single will have other effects on tax liability in future years. It is important to re-check your wage withholding forms (W-4 and state equivalents) to make sure that you are withholding enough money to avoid a large tax bill in future years. Many deductions and cut-off levels for tax benefits are different for single filers as opposed to married filers. In addition, make sure to re-check your insurance designation of beneficiary forms to be sure that your former spouse is removed from any of those plans, as well as any individual retirement accounts that are not being split in the divorce.