What Women Should Know about Post-Divorce Tax Planning

The early part of the year is often referred to as “divorce season” as it’s a popular time for couples to part ways. Regardless of when it happens, divorce is a significant time of change for women in many aspects, especially when it comes to their finances and money management. One financial aspect that can be particularly challenging with divorce is managing the resulting tax implications, with much more to consider than a change in filing status.

Upon divorce, understanding the more subtle aspects of tax planning is an important step for women in managing their finances. While tax planning can be complicated, there are a few considerations to keep in mind to simplify the process.

Determining your filing status

Your tax filing status is determined by your marital status as of Dec. 31 and will change to one of two options: Single or Head of Household. If you and your ex-spouse have children and your home will serve as their primary residence for more than half the year, you can file as Head of Household.

However, if your divorce is not yet final during the tax year, filing rules while you are separated vary by state. In this case, it is recommended to consult an adviser or an attorney to ensure you remain compliant with your state guidelines and choose the filing option that makes most sense for your financial plan.

Division of property

Home mortgage interest and real estate taxes are often a significant point of discussion during divorce, and who takes these deductions on their tax bill is a common question. You should have a clear understanding of who has the right to claim the deduction and accurately account for those payments. Additionally, the higher standard deduction under the Tax Cuts and Jobs Act may reduce the tax benefits if these expenses are being split.

Often, ownership of the home and the amounts paid for the mortgage determine who takes the tax deduction. If you share a mortgage, the deduction on your tax return should reflect your portion of the expenses paid, with the same applied for your ex-partner; they too can take deductions in proportion with the amount they are paying.

Sometimes, couples will retain joint ownership and share mortgage payments even after the divorce, often due to young children. In these cases, deductions should be split evenly. Keep in mind that the IRS typically awards the deduction to a partner who proves payment came from separate (not joint) funds.

Claiming children as dependents

Another question to consider for tax deductions is who will be entitled to claim each child as their dependent. The separation agreement can state which parent gets to claim which child. If the divorce settlement does not specify, then the custodial parent – the parent who has primary guardianship – gets to claim the exemption.

In cases where one parent is in a higher tax bracket than the other, it may make financial sense to trade or share the exemption, which can be done using an IRS Form 8332. For example, if a couple have two children and their divorce settlement allows one spouse to claim the same child each year, the parent claiming the older child will run out of the exemption sooner. As such, ex-spouses can agree to trade exemption years. Note that if you take this approach, be mindful of which child you claimed the previous year, as their information will need to be included on your return.

One important distinction to keep in mind with child deductions is that while exemptions can be negotiated, child-care credits cannot. Only the custodial parent can take child-care credits. As a result, only the custodial parent can utilize the allowance for a Dependent Care Flexible Spending Account.

Income and estimated tax payments

Following divorce, your stream of income is likely to be different from when you were married, especially if alimony and child support payments are received. Changes have been made to taxation of child support and alimony for divorces finalized after 2018. Child support is non-taxable, as is alimony, at the federal level. In addition, payments made for child support and alimony are no longer deductible from taxable income by the payor. State tax treatment of alimony varies, so check whether you’ll need to revise estimated state tax payments.  

With income earned from employment, which automatically withholds tax payments from your paycheck, you will likely need to recalculate estimated income tax and consider whether your W-4 withholding certification needs adjustments. One tip is that the thresholds for tax brackets for Head of Household filers are lower than those for joint filers. So, if you were the primary income earner in your marriage, you may need to withhold more tax by reducing the number of exemptions on your W-4 to avoid penalties for underpaid estimated taxes.

Dividing investments and asset allocation

Once your investments are divided and you are in possession of your assets, it is generally imperative that you have a comprehensive understanding of your portfolio and the resulting tax implications if you make changes to your investment strategy. Consider your new lifestyle expectations and requirements after divorce and review your asset allocation as you plan for the future.

For example, your portfolio as a married couple may have reflected more risk than you are comfortable holding as a single individual, and you’ll adjust accordingly. Whatever changes you choose to make, you should first understand how they will impact your tax bill to avoid surprises come tax season.

When reviewing investments, it’s also important to think about how much you have saved for your retirement. As a single individual, it’s likely that your income profile has changed, providing an opportunity to evaluate options for contributions to your retirement savings, whether it’s through a company sponsored plan or an individual account.

Thinking ahead

Following a divorce, there are many details to consider, and navigating the resulting tax changes can be cumbersome. In addition to these outlined considerations, it can be worth consulting a professional to assist you with your tax planning and preparation moving forward. More often, it makes sense to find a CPA or financial professional who can serve your needs as a single individual and help tie up additional financial loose ends.