December 17, 2022
5 Major Changes to Your Taxes After Divorce
When you get a divorce, almost everything in your life changes, including your living situation, relationships, and finances. What a lot of people don’t notice until the last minute is that some of the decisions you make during a divorce will inevitably impact your taxable situation. One of the best things you can do for yourself is to arm yourself with knowledge on what will affect your finances, so you can prepare in advance. Here are 5 major changes to be aware of that can affect taxes after a divorce.
Filing status
You’ve probably already guessed that the way you file your taxes will change. But you might still have options for your filing status, depending on a few factors1. Here are your potential choices, and what affects your eligibility:
- Married, filing jointly: The IRS encourages married couples to file jointly. To give you more incentive to do this, they offer several valuable tax credits. Often, joint filers can qualify for the Earned Income Tax Credit, the American Opportunity and Lifetime Learning Education Tax credits, and the Child and Dependent Care Tax Credit. If you would rather file jointly, you must be married through December 31st of the tax-filing year.
- Married, filing separately: There are rare circumstances where filing separately might benefit you. One of these has to do with medical expenses. The IRS only lets you deduct the amount of medical costs that exceed 7.5% of your adjusted gross income (AGI). If one of you has a high AGI, you might not be able to claim most of your expenses. In that case, if you were to file separately, it might be a good idea for the spouse with the lower AGI to claim the deductions.
- Single: Filing single has the same implications as filing separately. The only difference is your marital status. You can only file as single if your divorce was finalized by December 31st of the tax-filing year.
- Head of Household: Filing as head of household often makes more financial sense than filing single. Head of household filing status will earn you a higher standard deduction, and a lower tax rate. The ability to file with this status requires you maintain a household (meaning you paid more than 50% of the cost to maintain the home) for a qualifying person.
A qualifying person can include an unmarried child, a married child that you can still claim as a dependent, or parents that you support. If you have children and you are not the custodial parent, however, you cannot use a child to claim head-of-household2.
Tax Rates
If you earned a higher income than your spouse when you were married, your taxes could increase when you divorce. This is because you’ll be in a different tax bracket, and therefore taxed at a higher rate than when you were married.
Alimony and Child Support
Another major item that could affect your finances after a divorce is either making or receiving payments such as alimony and/or child support. Here’s what it means for your taxes:
- If you are paying alimony: As of 2019, you cannot deduct alimony payments from your Federal taxable income. Prior to December 31, 2018, you were able to deduct alimony, but the Tax Cuts and Jobs Act changed this benefit. Unlike many of the TCJA provisions impacting individuals and are schedule to expire after 2025, the elimination of the alimony deduction is in effect beyond 2025. California on the other hand allows the deduction of alimony on the California tax return.
- If you are receiving alimony: As of 2019, alimony payments you receive are not included in your Federal taxable income. Unlike federal taxes, currently California tax code considers spousal support taxable, so the receiving party will have to report any spousal support payments as income, unless otherwise agreed upon.
- If you are paying child support: You are not able to deduct child support from your taxes.
- If you are receiving child support: You are not required to include these payments as part of your income3.
Selling a Home
Many couples end up selling a house after divorce. If you sell your house and end up making a profit, you could potentially owe capital gains on that profit, but it some cases you might not. If you owned your home and used it as your primary residence for at least two out of the five years before you sell it, you can exclude up to $500,000 of any profit made from the sale of the house.
But you can only exclude that amount if you file a joint return, and as long as you haven’t excluded capital gains from another residential property in the two years before you sell the home. If your divorce is finalized before the sale and you both end up with partial ownership of the house, you can each exclude up to $250,000 in capital gains on your own return provided you meet the holding period requirements.
Shared Retirement Accounts
When you get a divorce and have determined what are considered to be community property assets, you will most likely have to divide retirement accounts. The manner this is done will vary depending on the type of retirement account you have – IRA, 401K, pension, etc. For example, if you’re dealing with a retirement account other than an IRA, a Qualified Domestic Relation Order (QDRO) will be required. This is used to divide up retirement plan assets between the owner of the account and their ex-spouse. Whether these retirement vehicles were established as pre-tax, post-tax or tax-free will ultimately dictate the taxability of these accounts, along with various other determining factors.
If these tax considerations sound confusing and overwhelming, you’re not alone. But taxes need to be considered when you’re assessing your overall financial plan – especially while going through a divorce. Luckily, there are people who can help. A Financial Advisor can be a huge asset, by looking at the whole picture of your finances for you. Consider working with an advisor that has the specialized training of a Certified Divorce Financial Analyst®, has a deep understanding of divorce settlements, and how to plan appropriately to ensure that every decision you make is in your best financial interest.
Jeneen Slack, CFP®, CDFA® is a Financial Advisor who works with her clients and their counsel to help handle the financial and practical elements of their divorce.