As if divorce weren’t unpleasant enough, there are tax consequences that need to be considered from the time of separation through the finalized divorce and thereafter. Some of the issues are actual benefits, but it’s important to be aware of how the taxman will be treating your change in marital status.
Unpaid Tax Bills
Just like all other marital debts, if a couple elected to file their taxes jointly, the unpaid tax bills are a joint obligation. So, if you were counting on your spouse to manage the taxes, and they didn’t pay, you will be on the hook for back taxes, penalties, and interest. If this happened to you, there may be an exception if you are an “innocent spouse” who didn’t know this was going on, so talk to an experienced divorce attorney in Maryland, who may need to bring in a tax attorney to help you sort this out. If you can’t prove you weren’t involved, this is another item that needs to be added in when dividing up the assets and debts of the couple. It’s also important to remember that, even if you are separated, you still have to pay marital taxes and coordinate whether you and your spouse are filing separately or jointly.
Timing Can be Important
For your tax bill in a particular year, your marital status on December 31 determines how you will file for the entire year. This means, if your divorce is finalized on December 30, you still need to file as single for that year. This is an important issue for couples who had been filing jointly since it impacts numerous credits and deductions. If you and your spouse have different levels of income, the divorce may move you into a different tax bracket (meaning you may have to pay a greater or lesser percentage of your income). When going through the divorce, give some thought to the timing to make sure it doesn’t cause you to pay a significantly larger amount for the year.
When an asset is sold, the taxman takes a percentage of your net profit on the asset – called capital gains. For an asset that has been held for a while, this can amount to a significant bill. Divorce involves a transfer in ownership of assets from the couple to the individual, but this is not treated as a taxable event, so there are no capital gains (or gift) taxes to pay at the time of divorce. However, the original value of the asset when it was acquired by the couple still applies if you decide to sell. When dividing the marital assets, it’s critical to take this eventual tax bill into account when deciding how you want to allocate.
Under Maryland law, spouses are entitled to a share of the retirement assets set aside during the marriage. This involves splitting up the existing retirement accounts and transferring them to new accounts. Under ordinary rules, any transfer of retirement funds out of the account can be subject to early withdrawal penalties as well as an income tax bill. The only way to avoid these consequences in a divorce is to obtain a Qualified Domestic Relations Order (QDRO) from the court. This applies to all IRA’s 401ks or any other retirement accounts.
Allocation of Child Credits and Deductions
Tax laws allow parents to take tax credits for their minor children as well as deductions for medical expenses. After a divorce, only one parent may obtain these benefits in a given year. If custody is shared, expenses split or child support is being paid, it’s important to work out who has these tax savings opportunities. Some parents agree to split the savings by alternating years, but this needs to be spelled out so that there’s neither a missed opportunity nor double dipping.
A big change in recent years is the tax implications of alimony. Under federal and Maryland law, prior to January 1, 2019 – alimony was tax deductible by the person paying, and taxed as income to the person receiving. Alimony is now treated as “tax neutral” and handled in the same way child support payments are not treated as income. If alimony and child support are part of a divorce settlement, be sure to talk to you family law attorney about the tax implications of both.
Tax laws are complicated, and divorce does nothing to make them easier. If you are considering or going through a divorce, be sure to work with an experienced divorce attorney in Maryland who can help you identify and resolve all of the tax implications.