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Understanding the basics of the tax consequences in divorce

| Jun 10, 2021 | Divorce

When you are going through a divorce, you must make financial choices. How will you equitably divide your marital property? How much child support will be paid and to whom? Will there be alimony, and if so, how much?

As you work with your attorney to negotiate a divorce settlement, your financial choices should include a basic understanding of how you could be taxed.

Alimony and child support

Before 2019, alimony was deductible by the payer and taxable to the recipient. That changed as of Dec. 31, 2018. Now, alimony is no longer deductible or taxable, just as is the case with child support.

One issue involving child support is how your children will be treated on your tax returns. You will need to decide which parent will deduct each child as a dependent and who will get the benefit of any child tax credits. How you do this will depend on your child custody arrangement and any agreements you have with your spouse.

The family home

Depending on how you decide to divide your marital home, you could end up owing capital gains taxes. This could happen if you sell the home to facilitate division and then don’t buy a new home with the proceeds. However, there is currently a tax exclusion for net profits that are less than  $250,000 per person or $500,000 per married couple.

If the profit you will see on the house will exceed the $250,000 exclusion, you may want to sell the house before the divorce is finalized so that you get the $500,000 married couple exclusion.

Other assets with capital gains

Selling certain assets, such as stock, could have tax consequences. These assets are taxed at the capital gains rate. Capital gains taxes are paid on the profit you make, generally meaning the price you sell for minus the price you paid.

Understanding what capital gains taxes could be due upon a sale should help you understand the relative value of each of your assets.

Retirement savings

The biggest tax consequence you could face is if you remove money from a tax-advantaged retirement savings account such as an IRA or 401(k). If you aren’t at retirement age, you will pay taxes and penalties if you take money out of these accounts, even to divide them into divorce.

Instead, arrange for any split of retirement savings to be done by the trustee who manages the account. In the case of a 401(k) or pension plan, you will need a qualified domestic relations order (QDRO) to authorize the trustee to distribute funds directly to your spouse without incurring the withdrawal taxes and penalties.

Your divorce attorney can help you understand these basics. In a complex divorce, your attorney may suggest bringing in a financial planner to value and divide your assets and debts.