When going through a divorce, taxes may not be your first priority. However, your tax status might dramatically alter during and after a divorce. Here are some of the most frequent tax issues that may arise during and after a divorce.
- It’s not unusual for someone’s tax position to radically alter after a divorce.
- Depending on whether you are divorced or just separated on or before December 31, you may have tax filing alternatives.
- There are many child tax credits available to parents; who receives them is determined by which parent is the custodial parent in the divorce.
- Pay close attention to the time of the sale of your property, which is one of the most valuable assets most couples own, in order to benefit from a greater exemption.
- Alimony payments are no longer deductible by the payer and so are not reflected in the recipient’s income.
What Is Your Filing Status?
Depending on where you are in the divorce process as of December 31, you may have alternatives for filing status.
Separated at year end but not yet divorced
If you are officially separated but not divorced on or before December 31, you will most likely file as married filing jointly (MFJ) or married filing separately (MFS) (MFS).
Despite not being formally divorced, you may qualify as head of home (HOH) under certain situations.
MFJ is nearly always preferable since it allows you to take advantage of tax advantages that are not accessible if you file MFS. In 2021, the standard deduction for MFJ would be precisely twice that of MFS. Married couples filing separately are typically not financially advantageous (with a few exceptions). It may, however, be a viable alternative for people who want to separate their funds as quickly as feasible.
Divorced at year end
If you divorce on or before December 31, you will be either a single filer or, if eligible, head of household (HOH).If you satisfy the following three requirements, you are eligible to be HOH:
- According to the Internal Revenue Service, you are deemed unmarried at the conclusion of the year (IRS).In order to be “considered unmarried” although formally married, your spouse must not have resided in your house for the last six months of the year, and you must file separate returns in addition to the other qualifications given above.
- You have an eligible individual in your house for more than half the year (certain exceptions to this requirement exist for children away at school and dependent parents who are in your care).
- You must have spent more than half of the annual cost of maintaining your house.
There are several advantages to filing HOH. The standard deduction for HOH is more than the standard deduction for a single filer. HOH permits you to claim certain tax breaks (explained in more detail in the next section).Furthermore, the lower tax categories have larger income ceilings for head of household filers than for single filers, resulting in lower effective tax rates for HOH taxpayers.
If your kid is the eligible person, you can only register as HOH if you are the custodial parent. The custodial parent is the one with whom the kid spends the most of the year. According to the IRS, if you have 50/50 custody of your kid, the custodial parent has the larger adjusted gross income (AGI).
Children of Divorced Taxpayers
When you and a previous spouse have children together, there are several tax implications. As previously stated, a noncustodial parent cannot claim head of household (HOH) status. A noncustodial parent cannot also claim their kid for the earned income tax credit (EIC), the American Opportunity Tax Credit (AOTC), or the child and dependent care credit.
The child tax credit is normally given to the custodial parent. However, if the custodial parent signs IRS Form 8332, waiving the right to claim the kid as a dependent, a noncustodial parent may claim their child as a dependant and earn this benefit. The credit has just been increased to $2,000 per qualified kid. The child tax credit has been doubled to $3,000 for children aged 6 to 17 and $3,600 for children under the age of 6 as a consequence of the American Rescue Plan for 2021.
Child support payments are not deductible by the payer and are not taxable income to the beneficiary.
Medical expenditures for the kid that the noncustodial parent pays may still be deducted, even if the custodial parent lists the child as a dependant. Both parents are able to claim any medical costs spent for their kid.
Alimony and Spousal Payments
Prior to the Tax Cuts and Jobs Act, alimony was taxed differently. Alimony payments were deducted from taxable income by the payer and included in income by the recipient for divorces concluded by December 31, 2018. Alimony payments are no longer deductible by the payer for divorces completed after December 31, 2018, and are hence not included in the recipient’s income. This new procedure is similar to how child support payments are handled.
Asset Transfers and Divisions
When a couple divorces, assets must be transferred or divided between the spouses.
Sale of a primary home
The family house is usually the most difficult thing for most couples to share. There are various things to consider if you sell your house as a consequence of your divorce. If you sell your property prior to divorce while you’re still filing jointly, you may be able to deduct up to a $500,000 gain on the sale. This exemption only applies to your principal residence, which you have resided in for at least two of the previous five years.
Each spouse is excluded from the $250,000 gain on the sale of a principal residence. As a result, if you are the only owner of the house after the divorce and then sell it, your exemption will be restricted to a gain of $250,000. If you and your ex-spouse co-own the house after the divorce and then sell it, you will each be entitled to a $250,000 exemption on any gain.
Retirement accounts transfers
You may be required to share your retirement funds with your ex-spouse under your divorce agreement. Cashing out your retirement account to compensate your spouse throughout the divorce process might result in a taxable position. Fortunately, the IRS enables a qualified domestic relations order (QDRO) to be used in this case to reduce the tax burden. A QDRO is a legal instrument that acknowledges that a spouse, former spouse, child, or other dependant is entitled to a certain amount of the other spouse’s individual retirement plan assets. It is frequently included in a divorce agreement.
Update Your W-4 at Work
When your circumstances change, such as a divorce, marriage, or the birth of a child, it is always a good idea to review your W-4 at work. Your paycheck withholdings and federal tax payments are determined by your W-4 form. Make sure you submit a new one with your HR department that reflects your new marital status.
My Spouse and I Are Legally Separated, but not Divorced. What Is My Filing Status?
For tax reasons, if you are officially divorced, the IRS considers you to be single. Otherwise, depending on the circumstances, your filing status is married filing jointly, married filing separately, or head of household.
Who Is Responsible for Taxes, Interest, or Penalties Due to the IRS in a Divorce?
If you and your ex-spouse filed jointly while you were married, you are equally liable for any IRS obligation. This is true even if your divorce settlement states that your ex-spouse is obligated to pay any sums owed on previously filed joint returns. However, the IRS provides relief under specific conditions.
Can I Claim Head of Household Filing Status After a Divorce?
Certain requirements must be met in order to claim head of household (rather than single) status. The simplest approach to find out whether you qualify is to fill out IRS Form 886-H-HOH, which includes all of the evidence required to claim head of household status. Before you file, be sure you qualify.
The Bottom Line
Divorce may have a substantial effect on your tax status. Divorce laws vary greatly by state, so be sure to understand any state-specific tax difficulties that may occur as a result of your divorce. This is a high-level summary of some of the most frequent tax issues that emerge after a divorce. It is always a good idea to check with a tax attorney or a certified public accountant (CPA) about any difficulties that are unique to your tax situation.
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