Last week, we began sharing some knowledge from an Investopedia article covering taxes and divorce. Divorce is a legal process that brings significant financial implications for those who go through it, and taxes figure into that picture. While we covered some basics about how filing status changes, there are some other things to be conscious about if you’re in the process of getting divorced or you’re recently divorced.
Child support payments are one of the biggest expenses that come with divorce, and as those who pay it are painfully aware, they’re not deductible, whereas if you’re receiving child support payments, you don’t have to count those as taxable income.
Investopedia also weighs in on medical expenses, which have some tax ramifications that aren’t as well known to divorcing and divorced parents. As that article notes, “Medical expenses for the child that are paid by the noncustodial parent can still be included in their medical expense deduction, even if the custodial parent claims the child as a dependent. Both parents are eligible to claim any medical expenses actually paid by them for the child.”
If alimony (or, as it’s known in Texas, spousal support) figures into your decree, there’s a relatively recent tax law change that might impact you — and makes spousal support a bit more of a burden for the payer than it was before.
“Alimony was taxed differently prior to the Tax Cuts and Jobs Act,” Investopedia notes. “For divorces that were finalized by December 31, 2018, alimony payments were deducted from taxable income by the payer and included in income by the recipient. For divorces finalized after December 31, 2018, alimony payments are no longer deductible by the payer and, therefore, not included in income by the recipient.”
In a number of divorces, a couple will decide to sell their home and split the proceeds, and there are certainly tax implications for that. “If you sell your home prior to divorce, while you’re still filing taxes jointly, you can be exempt from up to a $500,000 gain on the sale of the home,” the article points out. “This exemption is only for your primary home that you have lived in for at least two of the past five years.”
“Each spouse, individually, is exempt from $250,000 of gain on the sale of a primary home,” it goes on to say. “Therefore, if you are the sole owner of the house after the divorce, and you subsequently sell the home, you will be limited in your exemption to a gain of $250,000. If you and your ex-spouse co-own the home after the divorce, and you sell the home subsequently, you will each be entitled to a $250,000 exemption on any gain.”
Divorce can also impact what happens to retirement accounts, especially in community property states like Texas, but there’s a loophole of sorts that might help mitigate this.
“Your divorce agreement may require you to split your retirement savings with your ex-spouse,” the article notes. “Cashing out your retirement account to pay your spouse at the time of your divorce would cause a taxable situation. Thankfully, the IRS allows a qualified domestic relations order (QDRO) to limit the tax burden in this situation. A QDRO is a legal document, typically found in a divorce agreement, that recognizes that a spouse, former spouse, child, or other dependent is entitled to receive a predefined portion of the other spouse’s individual retirement plan assets.”
The article also recommends looking at your W-4 form and updating that with your employer as needed. That’s the form that determines your payroll withholdings, and it’s typically contingent on marital status. It’s possible to take more out than you’d typically be required to pay, if you’re looking to engineer a refund or you’re looking to make up for other income sources that might not be taxed. But if you leave your W-4 alone and you shift from married to single status, it’s possible that you’re not having enough taken out, and you’re putting yourself in an owing position for the following tax season.
While Investopedia’s a great source for general tax information, it’s also helpful for you to determine your own specific situation with an accountant, in order to know what to pay and what other strategies you can take on to improve your situation. And as you’re working with your lawyer on finalizing your divorce decree — for instance, with the Law Office of Lisa A. Vance — you might factor in your tax needs to how you aim to divide assets and debts.