Hannah Thoms, CPA, MST, CFP©
There are many emotional, personal and financial matters that need to be addressed when it comes to divorce. It is crucial that tax matters are taken into account before the divorce is final. Below are a few key considerations.
What is your filing status?
If you are still married on December 31st then you are still considered married for the entire year. Your filing status is either married filing jointly or married filing separately.
Consideration: Is it worth the risk to file jointly since you would be liable for your former spouses income tax? However, if filing married separately, you may be losing out on potential tax savings of married filed joint.
If you are unmarried by December 31st, you are considered divorced for the entire year. Your filing status is either single or head of household. You may be eligible to file head of household if you have a child even if the child is NOT considered your dependent for tax purposes. Head of household status results in a better tax situation than single status.
Consideration: When there are two or more children, with proper planning, both parents may be able to claim head of household status.
Who claims the children?
The custodial parent is entitled to the dependency exemption. The custodial parent is the parent that the child lived with for the greater part of the year. If equal, than the parent with greater adjusted gross income is treated as custodial parent.
Consideration: There is opportunity for non-custodial parent to claim child if custodial parent agrees and files Form 8332. The exemption can be released for one year, for a number of years or for all future years.
Is it subject to income tax?
– Child support payments are not considered taxable income.
– Alimony is generally taxable income to the recipient and deductible to the payor.
Consideration: Taxable alimony can be treated as compensation for IRA contribution purposes.
– Assets transferred as part of divorce settlement agreement are not taxable. Note that tax basis and holding period of the property transfers with the property.
Consideration: In property settlement, the spouse receiving low-basis asset should consider negotiating for future tax paid when asset is sold.
– Qualified domestic relations order (QDRO) is a court order for direct transfer of an interest in a qualified employer retirement plan to a former spouse. The former spouse can take it as a taxable distribution (not subject to 10% early withdrawal penalty) or roll it over into an eligible retirement account.
– Individual Retirement Accounts (IRAs) can be transferred to former spouse by changing name on the account or making a direct trustee-to-trustee transfer of IRA without resulting in a taxable event.
Consideration: Withdrawing funds from qualified retirement plans and IRAs to satisfy divorce decree would result in taxation and possible penalty to the account owner.
The above is a broad overview of some of the tax considerations relating to divorce. Every divorce is unique and so are the related tax matters and that is why it is important to review the tax implications before the divorce is final.
Hannah Thoms, CPA, MST, CFP©, is a Senior Manager and specialist in the areas of estate, tax and personal financial planning at Gordon Advisors, P.C. She has over 16 years’ experience with assisting clients in developing strategies to meet their financial planning objectives, while saving current tax dollars and minimizing future tax implications.
Hannah is a member of the American Institute of Certified Public Accountants, the Michigan Association of Certified Public Accountants and the Estate and Financial Planning Council of Metropolitan Detroit. She is actively involved with Walsh College, where she received a bachelor of accounting and a masters of finance. Hannah is also a 2011 graduate of Leadership Oakland.