Divorce and Taxes: What Changes and What Doesn't

How Divorce Affects Your Tax Situation

Divorce triggers numerous tax changes that affect your filing status, deductions, credits, and obligations. Understanding these changes in advance allows you to plan strategically and avoid costly surprises at tax time. This guide covers the key tax implications of divorce that every divorcing person should know.

Filing Status Changes

Your filing status for the tax year is determined by your marital status on December 31 of that year. If your divorce is final by December 31, you file as Single or Head of Household. If you are still legally married on December 31, you may file as Married Filing Jointly or Married Filing Separately.

Head of Household status provides more favorable tax rates and a higher standard deduction than Single status. To qualify, you must be unmarried on December 31, have paid more than half the cost of maintaining your home, and have a qualifying dependent living with you for more than half the year.

Child-Related Tax Benefits

Several valuable tax benefits are tied to having dependent children:

Child Tax Credit

The parent who claims the child as a dependent receives the Child Tax Credit. Typically, the custodial parent (the parent with whom the child lives for more than half the year) claims the child. However, the custodial parent can release the claim to the non-custodial parent by signing IRS Form 8332.

Child and Dependent Care Credit

Only the custodial parent can claim the credit for childcare expenses. This credit covers a portion of daycare, after-school care, and summer camp costs that enable the parent to work.

Earned Income Tax Credit (EITC)

The EITC is available to the parent who claims the child as a dependent and meets income requirements. This credit can be worth several thousand dollars for lower-income parents.

Spousal Support Tax Rules

For divorces finalized after December 31, 2018, spousal support payments are not tax-deductible for the payer and are not taxable income for the recipient. This change from the previous law significantly affects the economics of spousal support negotiations.

For divorces finalized before January 1, 2019, the old rules still apply unless the decree has been modified to adopt the new rules. Under the old rules, payments are deductible for the payer and taxable to the recipient.

Property Transfers

Transfers of property between spouses or former spouses incident to divorce are not taxable events. However, the receiving spouse takes over the transferor's tax basis. This means future sales of the property will be based on the original cost basis, not the value at the time of transfer. This has important implications for assets that have appreciated significantly.

Retirement Account Distributions

Properly handled retirement account transfers incident to divorce are tax-free. However, if funds are distributed rather than rolled over, taxes and potentially penalties will apply. Ensure all retirement account divisions are handled through the appropriate legal mechanisms (QDRO for employer plans, transfer incident to divorce for IRAs).

Capital Gains on Home Sales

Selling the marital home can trigger capital gains taxes. The Section 121 exclusion allows individuals to exclude up to $250,000 in gains, or $500,000 for married couples filing jointly. Timing the sale in relation to the divorce can affect which exclusion amount applies.

Planning Ahead

Work with a tax professional during the divorce process, not just at tax time. Many divorce-related tax decisions are time-sensitive and can save or cost you thousands of dollars. Your tax advisor should be consulted before finalizing your settlement agreement to ensure the tax consequences are fully understood and accounted for.

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