Updated: May 20
When a marriage or civil partnership breaks down, the last thing on your mind is the effect that the break-up might have on your relationship with the tax man. Separation and divorce have “hidden” tax issues that can be traps for couples. Below are a few “traps” to avoid and some general information regarding the tax consequences which associated with separation and divorce.
Filing Taxes When You are Separated
The IRS allows couples to file jointly as if they were still living together as long as they are not legally divorced on December 31 of the tax year they are filing. If you do obtain a divorce, you are precluded from filing jointly.
Filing jointly may be advantageous from a tax perspective. It’s common for separated spouses to file jointly when separated, but you should apportion the tax payments and any refunds accordingly.
Tax Consequences of Alimony
Support payments, whether they are post-separation support (also known as “temporary alimony”), or permanent alimony, are income for the spouse that receives the support (“payee” or “dependent spouse”) and a deduction for the spouse that pays the support (“payer” or “supporting spouse”). When negotiating alimony, don’t forget this important tax consequence.
Alternatively, if the supporting spouse has income that places him or her in the 25% tax bracket, he or she gets to deduct alimony paid to the dependent spouse dollar-for-dollar against other income, thus reducing the taxes. State tax consequences need to be considered also.
Tax Consequences of Child Support
Basic child support payments are not taxed to the parent receiving the support, and are not a deduction for the parent paying support. However, there are tax benefits associated with child support, such as tax exemptions and daycare credits. You can negotiate with the other parent as to who gets the tax exemption if the exemption aids one parent more because of a discrepancy in incomes.
Tax Consequences of Sale of Stock
When dividing the marital estate (a legal term meaning the assets of the marriage), the sale of stocks and other financial assets may have tax consequences. This should be taken into account when dividing these assets. It is recommended that you contact your accountant or financial adviser to determine the tax consequences associated with these sales.
Tax Consequences of Transfer of 401(k)s, IRAs
Generally, the division and transfer between spouses (and ex-spouses) of pensions, 401(k)s and IRAs are non-taxable events to the spouse that is getting his or her share of the retirement asset. However, the transfer of these types of retirement assets must be “incident to a divorce” to avoid federal taxes.
The failure to follow the IRS and state tax rules regarding division of these assets may result in serious tax penalties and taxes. This is not to be considered tax advice and you should talk with an accountant or some other qualified professional.
Separation and divorce are expensive and complicated. Filing tax returns to the best benefit of the family unit is harder, too. Alimony, child support and/or the sale or transfer of stocks, bonds, and/or retirement assets such as pensions, 401(k)s, and IRAs, may have serious tax consequences. Be aware that any expensive failures can follow the relationship breakdown.
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