When people marry, they commit to a united approach to life, which includes financial issues like taxes. Even couples who file taxes separately have to have some coordination for purposes of accurate filing. When marriage ends in divorce, the status quo is thrown into some turmoil, and it is well worth working with professionals with expertise in family and tax law to navigate a more complex tax situation. Here are some important issues that you need to consider.
Timing is Meaningful
The IRS and the Comptroller of Maryland calculate income, deductions, and other tax issues annually, and that year begins January 1 and ends December 31. Your filing status depends on whether you are divorced or legally separated at the end of the year. Since filing jointly with a spouse can affect your income tax bracket, it is essential to bear this in mind when tax planning during a divorce.
Head of Household
If you and your ex have children or other dependents, your divorce and custodial arrangements impact whether you can continue to apply a deduction as head of household. It is critical to get clarity in a settlement agreement or from the court following a divorce trial about how the dependent deduction is allocated between you and your ex. While some co-parents alternate years taking the full deduction, other compromises may be available. A tax and family law expert can assist with this.
Retirement Accounts
Unless there is an explicit, enforceable prenuptial agreement, spouses have an interest in each other’s retirement accounts. When dividing assets in a divorce, the funds in these accounts need to be included in the division. However, ordinary tax rules apply a penalty for early withdrawal of funds from a retirement account, which would be a transfer to the other spouse. The taxing authorities have resolved this using a Qualified Domestic Relations Order (QDRO). If obtained and properly applied, the QDRO prevents a big tax bill for the division.
Capital Gains
Under Maryland law, any property transfer can result in being on the hook for paying capital gains or taking a deduction for capital losses. This includes potentially significant amounts when it comes to the family home, significant investments, or cars. An exception is carved out for transfers between spouses in a divorce. This requires identification of the asset in a divorce decree. Since the exception may not apply if the asset is sold as part of the divorce, consider capital gains issues when deciding how to manage valuable assets being divided in a divorce.
Alimony Payments
For any divorce finalized after December 31. 2018, alimony payments are no longer tax deductible by the payor, nor are they treated as income to the payee. This means that a significant expense to the person paying spousal support cannot be used to offset income taxes. There may be some strategies to mitigate this expense, such as working with a tax professional.
When going through a divorce, you must be aware of the tax implications of your decisions. If you are unsure or have significant assets, seeking advice from family and tax law experts can help manage these complexities effectively.