Taxes are understandably low on the list of things people worry about when they’re getting divorced, but ignoring Uncle Sam can be an expensive mistake. Here are seven things the pros say you should do right away to avoid a tax surprise when the rings come off.
1. Check the calendar
- For tax purposes, your marriage status on Dec. 31 is usually your marriage status for the whole year, notes Paul Joseph, a certified public accountant and attorney in Williamston, Michigan. So if you expect your tax bill to go up after your divorce, and you’re not prepared for that yet, consider waiting until Jan. 1 to make things official.
- A tax pro can help you run before-and-after scenarios.
2. Start gathering account statements
- You’ll need them to inventory your assets and liabilities, as well as to determine whose names are on the accounts. “You should start creating your own statement of net worth,” says Molly Burton, a certified financial planner at Tobias Financial Advisors in Plantation, Florida.
- “You should be gathering as much information as you can about your assets — and that includes the home, any tangible assets, the cars, investment accounts, retirement accounts, any loans,” she says.
3. Hire pros
- “It really and truly takes a village to get a couple divorced,” says Vicky Townsend, CEO of the National Association of Divorce Professionals, which provides a directory of member lawyers, accountants, real estate agents and other experts who provide services in divorce matters.
- Another option is to search the Institute for Divorce Financial Analysts website for professionals who carry the Certified Divorce Financial Analyst designation.
4. Make a plan for the house
- If you’re selling the house, it might be better to do it while you’re still hitched, says Chicago-based attorney Tony Madonia. That’s because the IRS exempts the first $500,000 of gains on the sale of a primary home if you’re married filing jointly, but for single filers the exemption is only $250,000.
- Generally, you need to have lived in the house for two of the last five years. For example, if you originally paid $200,000 for your house, and it’s now worth $700,000, selling it while you’re married could keep that $500,000 gain tax-free. Sell it when you’re single, however, and suddenly $250,000 of your gain could be taxable.
- That exemption generally applies only to a primary residence, not second homes or rental properties, Madonia adds.
Take charge of your financial life right now
- Learn how to save money, from adjusting daily and monthly habits to making long-term changes.
- Building a budget isn't magic, but it represents more financial freedom and a life with much less stress.
5. Factor in the tax effects of the kids
- Generally, a parent with whom a child lives at least half the year and who provides at least half of the child’s support can claim the dependent exemption, as well as the child tax credit and other related deductions and credits if the parent is eligible, Joseph says.
- The parent might also be able to use the head of household tax filing status, which has its own advantages.
- There are exceptions, however, so be sure the divorce decree explicitly details everything, he notes.
- Also be sure there is a signed Form 8332, which tells the IRS what you’ve agreed to on the exemption.
- If your ex is being obstinate, doing your taxes early could help, Madonia says. “File your return right away with the dependency exemption, because your spouse’s return will then be bounced for claiming those same exemptions. And at least you will be first in line to have them,” he explains. “You’ve certainly got more bargaining chips if you do that.”
6. Know the rules for alimony and child support
- In 2018, payments made for child support aren’t tax-deductible, but payments made for alimony are. Likewise, payments received for child support aren’t taxable, but payments received for alimony are.
- In 2019, the alimony rules change: Payments made for alimony are no longer deductible if the divorce occurs after Dec. 31, 2018, or if an existing divorce is modified to explicitly include this change. Payments received for alimony are no longer taxable.
- The tax deduction for paying alimony in 2018 can be valuable for people in high tax brackets, Madonia says. If you’re receiving alimony in 2018, though, plan ahead for the tax bill, he warns.
- Usually, nobody’s withholding taxes from an alimony check (the way an employer would on your paycheck), so you may need to make estimated tax payments during the year. You could also increase your withholdings at work to help offset the alimony taxes, he says.
7. Mind the tax hit when splitting assets
- From a tax perspective, getting $100,000 of cash in a divorce settlement can be very different than getting $100,000 in stocks, Joseph warns. That’s because for the stocks, you might have to pay capital gains tax later on the difference between your basis — typically, what you paid for the shares — and what you sell them for.
- Similarly, low-basis investments could generate more capital gains taxes than high-basis investments. For example, if you get a stock portfolio worth $100,000 in the settlement, you might pay more capital gains tax if the stocks originally cost $25,000 than if they cost $95,000.
- That could change the way you decide to split up assets. “Even when assets are divided 50-50 — I mean right down the middle, to the penny — if you don’t look at the tax consequences, then it really isn’t 50-50, and in fact it could very well be detrimental to you,” Madonia says.
» Ready to work with a financial planner? The form below will put you in touch with an advisor at Facet Wealth, a fee-only, fiduciary online planning firm. They aren’t tax preparers, but they can help you with tax and estate planning.