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Tax Consequences of Divorce

April 3, 2009

Divorce can involve many potential tax traps and pitfalls. You will be changing your tax status and that alone, can have quite an effect on your financial life. Here are some things to be aware of:

Filing Status

Since you will no longer be filing as “married,” you will want to make sure that your withholding is in keeping with your new filing status. If you have children, and you have not remarried, you may opt to file as “head of household,” the non-custodial parent will usually file "single." In joint custody cases where there is more than one child, it can be advantageous for each parent to claim one child, regardless of where the child resides most of the time. In this way, both parents could, potentially, qualify as "head of household." The benefits of "head of household" tax rates are far better than those for filing “single.”

Child Support

Both parents have a legal duty to support their child according to their ability to do so. For this reason, child support is neither taxable to the recipient, nor tax deductible to the spouse paying, regardless of which parent retains custody of the child or where the child resides a majority of the time. In order to claim your child on your tax return, all dependency tests must be met for either a "qualifying child" or a "qualifying relative." For more information about who qualifies, visit irs.gov.

Although, the parent who has custody of the child for the greater part of the year, generally has the right to claim that child as a dependent, the custodial parent may transfer the dependency exemption to the other parent by signing Form 8332. If you offer to give away a deduction you may be able to work out an amicable arrangement with your ex-partner, so that you both reap the benefits.

Alimony or Spousal Support

A divorce agreement should clearly state the difference between alimony and child support. A substantial spousal support or alimony payment can be a large tax deduction for one spouse, and a huge tax liability for the other, because alimony is tax-deductible for the person making the payments and taxable to the person receiving. Beware of how all kinds of support are distinguished in your agreement.

If your agreement combines the alimony, family and child support together into one payment, the entire payment will be considered spousal support and will be fully taxable to the recipient.

Other Income or Deductions

When splitting other marital assets, income such as interest and dividends, can also have a dramatic impact on your finances. Assuming one of the parties wishes to remain in their home, mortgage interest can be divided or eliminated completely depending on who retains ownership. The equity in the home can be divided between the two parties and the spouse remaining in the home can arrange a new mortgage, as sole owner. This relieves any responsibility to mortgage payments owed by the spouse who chooses to remove themselves from the home.

Likewise, additional assets, such as rental property, will also be divided, and the tax burden will fall upon the person retaining ownership of that property.

In the long run, as a divorcing couple, as long as you negotiate and honor your agreements in good faith, you will save yourselves money and aggravation. Whatever your circumstances and despite the stressfulness and anguish of this emotional time; working together with your partner during and after a divorce, can eventually lead to an equitable place, where the needs of all parties, including your children, are met.

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Tax Consequences of Divorce

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