When going through divorce, not enough people pay attention to the tax consequences of different settlement options. We thought we would highlight some of the key tax issues to consider during and after divorce.
First, child support is not deductible. Many parents who pay child support wonder why child support is not a deductible expense, and the simple answer is, because the Internal Revenue Code says so. Usually a parent paying child support cannot claim the child as a dependent and cannot get the childcare tax credit; the IRC assumes (not always correctly) that the parent who can claim the child as a dependent makes all of these payments and so to give the paying parent a deduction would be double dipping the expenditures.
Second, maintenance, or spousal support, is a deductible expense so long as it is court-ordered and the two former spouses no longer reside together in the same household. Also, maintenance is considered income and taxable to the recipient. Parties trying to arrive at a proper maintenance sum should consider the tax implications – the party paying receives a tax benefit up to 39% of taxable income, the party receiving has a tax burden of 20-25% generally.
Third, for spouses deciding who will receive the marital home, the party paying the mortgage on the home can deduct the interest up to $1 million and also on home equity loans up to $100,000. Further, if the spouse who does not receive the home purchases a new home, that spouse can also utilize the same tax benefits for mortgage interest. Importantly, if the parties will sell the home, the parties have a limited time – six months – to transfer the equity from the home into the down payment on a new home to avoid a capital gains tax.
Fourth, the spouse who has the child the majority of the time can claim the dependent care exemption. In Missouri, the child support guidelines assume the party receiving support also gets the dependent care exemption. So, if the parties want to alternate years or divide the claiming of multiple children, they must secure a waiver from the other party every year for the claiming of the deduction.
Finally, contributions to retirement funds can have valuable tax benefits and continue after divorce for the party making those contributions. In a regular IRA, that could mean at least a deduction of $5,500 (more for self-employed persons).
All of these deductions have real impact on the bottom line of each spouse moving forward after divorce and should be part of any discussion regarding settlement.
If you have questions regarding tax deductions and divorce, contact us – we can help.