For most newly divorced people, doing taxes the following year after the divorce brings up important questions that can be stressful. Here’s what you need to know to successfully make the transition.
Taxes can be complicated after a divorce due to the divvying up of assets and splitting income as well as paying or receiving alimony. If you have kids, it get’s even more complex.
Re-allocating Property
If you sell your house, the tax on the principal gain on the sale can be avoided up to $250,000 and now, since you are 2 separate taxpayers, that can be applied to both parties making $500,000 of the capital gain be tax-free. This can be helpful towards getting a refund or reducing your tax bill. However, you will have to have lived in the house as a primary residence for 2 of the last 5 years.
If one of you were to keep the house, that person can use the tax credit for the mortgage interest deduction. Basically, the portion of your mortgage payment that goes towards interest and not principal is deductible.
If the home has not been lived in as a primary residence for 2 years and the sale of the house was after the divorce, you may be able to avoid tax on a portion of the capital gains. For example, if you only lived there a year, you may be able to have up to $125,000 be non-taxed.
Filing Status
Whatever your marital status is as of December 31st determines how you are able to file. So if you were officially divorced within a tax year, you’re not able to file jointly for that year—even if you were married most of the year. However, you may be able to file as head of household which has a larger benefits and you’ll more than likely have a lower tax bracket as well.
Child Support Vs. Alimony
Essentially, income you receive from Child Support is not taxable but, Alimony is taxable income. Conversely though, Child Support is not deductible by the person paying it and Alimony payments made are deductible.
Claiming Dependents
You can claim your dependents if you meet the criteria to be considered a custodial parent. To be a custodial parent, your dependent will need to have lived with you for more than 50% of the time more than with your ex-spouse.
A non-custodial parent can claim a dependent if the custodial parent has signed form 8332, which is the “Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.” There are times where this makes the most financial sense. For example, should a custodial parent not be eligible for the dependent deduction due to qualifying for the Alternative Minimum Tax (also known as, AMT), it may make sense for the non-custodial parent to be able to claim the dependent so that benefit is not left on the table.
Some ex-spouses alternate years of who can claim—usually in a joint custody situation. In the past, a divorce agreement could specify who could claim the dependent(s). However, this is no longer the case and the above mentioned form 8332 must be used to designate rights to claim dependents.
Child Tax Credits
It’s important to note that a tax credit is different than a tax deduction. A deduction, like you would receive for claiming a dependent, reduces the amount of taxable income you are responsible for—lowers your tax bracket. A tax credit reduces the amount of taxes you owe.
In order to be able to be eligible for child tax credits, you have to be eligible for the claiming the dependent deduction(s).
Retirement Account Transfers
Cashing out a retirement plan such as a 401k is considered a taxable event. However, in a divorce you may be able to avoid paying taxes on distributed funds from the retirement account to an ex-spouse should you take the necessary precautions in the divorce agreement.
You’ll need to do the retirement account transfer within what’s called a Qualified Domestic Relations Order—also referred to as a QDRO. This allows for your ex-spouse to receive the the funds without you having to pay taxes on the distributed amount. However, the ex-spouse receiving the funds will be taxed on the amount distributed to them.
Use a Tax Professional
With divorce bringing about so many complications, it’s best to use a qualified tax professional to navigate your unique tax situation.