Tax Time for Divorced Persons – Part Two

hidden assets

In our previous post we discussed the change in filing status that follows from divorce, and the impact that change has on claiming dependents. In this post, we continue looking at tax issues, focusing on spousal support and property distributions from divorce.

If the court ordered one spouse to pay maintenance to the other spouse, the spouse paying the support can deduct these payments from gross taxable income – in other words, the real cost of spousal support is not just the dollar value paid annually but actually the after-tax impact too – so if you pay $10,000 in maintenance, the after-tax value is less than $10,000, perhaps far less if it really drops your marginal tax rates.

On the flip side, if you are the spouse receiving support, you must claim that as income. So, for many individuals receiving maintenance, the tax consequence could be significant – where you may have had a sizable refund due to low earnings and other deductions, the additional income will increase the marginal tax rate and also hike up the threshold for claiming other deductions such as health care expenses.

If you are ordered to pay child support, please note you cannot claim any of those amounts as deductions on your federal taxes.

If you divorced last year and you had to sell the marital home, the tax consequences could be tricky. If you sold the home for a profit, that profit is taxable as income or capital gain. However, if you take the proceeds and use them to buy a new principal residence, you will not have to pay any tax on the profit. Unless otherwise stated in your divorce decree, if you and your former spouse both owned the home jointly, you will both be responsible for the tax issues related to the sale.

If you divorced last year and the court awarded a division in retirement accounts, you could have tax consequences. In general, any early withdrawal from an IRA carries both an income tax and an early withdrawal penalty. So, to avoid the harsh tax loss, rollover any shares in retirement funds into your own retirement accounts or a separate new account for these benefits, but you must do so within six months of the transfer. Also, you may need a Qualified Domestic Relations Order (QDRO) to effect the transfer. Also, if you feel you need to access funds, going to withdraw newly received retirement benefits should be a last resort given the severe tax impact; you would be better taking out a loan given the current interest rates.

As you can see, property issues can be landmines for hidden taxes, so it helps to know what different types of transfers or encumbrances will do to your bottom line.
If you have questions about tax consequences of divorce, contact us – we can help.

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