If you're going through a divorce, the last thing you may have on your mind is how the breakup will affect you and your ex-spouse on your next tax return. But whether you're structuring a property settlement, choosing how to split up retirement savings or simply figuring out what your filing status is after you part ways, we can help make the transition easier.
Couples who are splitting up but not yet divorced before the end of the year still have the option of filing a joint return. It's when your divorce decree becomes final that you lose the joint return option. Your marital status as of December 31 controls your filing status. If you can't file a joint return for the year, you can file as a head of household after your divorce (and get the benefit of a bigger standard deduction and gentler tax brackets) if you had a dependent living with you for more than half the year and you paid for more than half of the upkeep for your home. If your divorce is still pending at year-end, you can either file a joint return (which is likely to save you money) or choose the married-filing-separately status.
Exemptions for Dependents
You can continue to claim your child as a dependent on your tax return if the divorce decree names you as the custodial parent. If the decree is silent on that point, you would still be considered the custodial parent — and thus eligible for the exemption — if your child lived with you for a longer period of time during the year than with your ex. (It's possible for the noncustodial parent to claim the exemption if the custodial parent signs a waiver pledging that he or she won't claim it.)
Remember, too, that if you're the parent who claims the dependent exemption, you're also the one who has the right to claim the child credit or an American Opportunity or Lifetime Learning college credit. Put another way, if you can't claim the exemption, you can't claim those credits, even if you pay the college bills.
If you continue to pay a child's medical bills after the divorce, you can include those costs in your medical expense deductions even if your ex-spouse has custody of the child and claims the dependency exemption.
You can continue to claim the child-care credit for work-related expenses you incur to care for a child under age 13, if you have custody even if your ex gets to claim the dependency exemption. But only the parent who claims a child as a dependent may claim the $1,000 child tax credit.
Payments to an Ex
If you're the spouse who is paying alimony, you can take a tax deduction for the payments, even if you don't itemize deductions. Keep in mind, though, that the IRS won't consider the payments to be true alimony unless they are spelled out in the divorce agreement. Your ex, meanwhile, must pay income tax on those amounts. The opposite is true for child support: The payer doesn't get a deduction and the recipient doesn't pay income tax. (Be sure you know your ex's Social Security number. You have to report it on your tax return to claim the alimony deduction.)
When a divorce settlement shifts property from one spouse to another, the recipient doesn't pay tax on that transfer. That's the good news. But it's important to remember that the property's tax basis shifts as well. Thus if you get property from your ex in the divorce and later sell it, you will pay capital gains tax on all the appreciation before as well as after the transfer. That's why, when you're splitting up property, you need to consider the tax basis as well as the value of the property. A $100,000 bank account is worth more to you than a $100,000 stock portfolio that has a basis of $50,000. There's no tax on the former, but when you sell the stock, you will owe tax on the $50,000 profit.
If, as part of your divorce, you and your ex decide to sell your home, that decision may have capital-gains tax implications. Normally, the law allows you to avoid tax on the first $250,000 of gain on the sale of your primary home if you have owned the home and lived there at least two years out of the last five. Married couples filing jointly can exclude up to $500,000 as long as either one has owned the residence and both used it as a primary home for at least two out of the last five years.
For sales after a divorce, if those two-year ownership-and-use tests are met, you and your ex can each exclude up to $250,000 of gain on your individual returns. And sales after a divorce can qualify for a reduced exclusion if the two-year tests haven't been met. The amount claimed depends on the portion of the two-year period the home was owned and used. If, for example, it was one year instead of two, you each can exclude $125,000 of gain. What happens if you receive the house in the divorce settlement and sell it several years later? Then you can exclude a maximum of $250,000. The time your spouse owned the place is added to your period of ownership for purposes of the two-year test.
Transfer of Retirement Assets
Handle your retirement savings with care in a divorce. If you cash out a 401(k) plan to give the money to your ex, for example, the IRS considers that a taxable distribution, and you'll be stuck paying the tax. The way to avoid this tax trap is to have the transfer accomplished under a qualified domestic relations order (QDRO), which gives your ex the right to the funds and relieves you of the tax burden. You don't need a QDRO to transfer IRA funds, but the transfer should be spelled out in the divorce settlement so that it's not deemed a taxable distribution.
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