The number of divorces are expected to rise this year and tax season is just around the corner. Planning for divorce also includes considering how your decisions will affect your taxes.
Your martial status on Dec. 31, 2020 determines your filing status. If you were not officially divorced by the end of last year, you can file a joint return which usually saves money or select the married-filing-separately status.
You may file as head of household if you have a dependent living with you for over half the year and paid for more than half of your home’s maintenance or as a single taxpayer. This allows taxpayers to reap the advantages of a larger standard deduction and being in a better tax bracket.
In addition to reviewing your filing status, you also need to file a new W-4 with your employer to adjust the tax withholding amount from your paycheck.
A spouse paying spousal support may deduct payments if the divorce agreement existed before the end of 2018. Otherwise, alimony is not deductible for the paying spouse and is not taxable income for the recipient. This deduction is also unavailable if the divorce agreement is changed after 2018 to exclude this support from your spouse’s income.
Cash-only payments qualify as deduction if it is set forth in the divorce agreement. You must report your former spouse’s Social Security number so the IRS can verify that the recipient spouse reported the support as taxable income.
Generally, the custodial parent who lives with their children for most of the year can claim the child tax credit or credit for other dependents for the couple’s qualifying children. The child tax credit is $2,000 for each child and up to $1,400 is refundable. The credit for other dependents can be up to $500 for each qualifying dependent such as a child over 16 years old.
A noncustodial parent may claim one of these credits for their child and file a form 8332 if the other parent signs a waiver and gives up their claim to an exemption for that child on their return. This may have advantages if the noncustodial parent is in a higher tax bracket.
Children’s medical expenses
A spouse who pays a child’s medical bills after their divorce can include these costs in their medical-expenses deductions even if their former spouse has custody of that child. Medical expenses for 2019 are deductible only to the extent they are above 7.5 percent of adjusted gross income.
A recipient is not taxed for property that is transferred to them under a divorce settlement agreement. But the recipient’s tax basis shifts. If that spouse later sells that property, they will pay capital gains tax on the appreciation before and after the transfer.
Selling the house
The timing of the sale of the couple’s home, if they decide to sell it, has tax consequences. Typically, there is no tax on the first $250,000 gain of the sale of the primary home if the couple owned and lived in it at least two of the last five years. A couple can also exclude up to $250,000 of the gain on their individual returns for post-divorce-sales.
If the sale did not occur within two years, a post-divorce sale can qualify for a reduced exclusion. The tax-free restriction depends on the portion of the two period where the home was owned and used.
A taxpayer should have earned income from a job or self-employment to qualify for an IRA contribution. There is an exception for some divorced spouses.
Taxable spousal support received by a spouse is considered as compensation for making IRA contributions. A spouse can contribute up to $6,000 to a traditional or Roth IRA or a combination of these accounts. A spouse who is at least 50 can contribute an additional $1,000 for the year.
Anyone undergoing divorce should seek financial and legal advice when considering their tax requirements. An attorney may also help spouses consider property division and other options that address their financial needs.