Divorce comes with a variety of tax consequences, which many people fail to consider. During proceedings, matters of property division and spousal support may seem more important. Yet, the decisions you make about these can affect your taxes as well. Acknowledging their impact can help you plan ahead financially.
If you and your spouse are dividing retirement accounts in your divorce, you must make sure you do so with care. To split these assets properly, you must fill out a qualified domestic relations order (QDRO). A QDRO will outline the share of your retirement accounts your spouse will receive, as well as when their payout happens. So long as your QDRO enters court records, it will allow for a tax-free transfer of your retirement assets.
You and your spouse are likely homeowners, and you may decide to sell your house during your divorce. If you two still file taxes jointly, you can exempt up to $500,000 of the sale’s profit from your income. To do so, though, you must have made the property your primary residence for at least two of the last five years. If you and your spouse sell your home after divorcing, yet still share ownership of it, you can each exclude up to $250,000 of the sale’s profit from your income. You can also exclude this amount if you receive the house in your divorce settlement and sell it thereafter.
If you and your spouse earn unequal incomes, spousal support may factor into your divorce settlement. In this case, you will want to consider new federal laws – effective since January 2019 – that affect its taxation. Under prior laws, payers of support deducted their obligation from their taxable income, whereas recipients included it as part of theirs. Now, recipients of spousal support can deduct it from their taxable income, whereas payers cannot. These laws can put both parties at a disadvantage. If you are the paying spouse, they could increase your tax obligation. If you are the receiving spouse, your support will likely decrease due to your spouse’s increased tax burden.
Going through a divorce will have tax consequences, no matter how hard you try to avoid them. But by knowing their implications, you can work to minimize their effects on your finances.