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Dealing With the Tax Consequences of a Divorce

Tax Consequences of Divorce

Divorce is a beast that touches every aspect of your life—your mental well-being, physical health, and finances, to name just a few. In fact, it’s possible that your divorce settlement may even affect your taxes. That’s why it’s so important to work with an attorney while figuring out your divorce in Kentucky. Without a lawyer, you risk making agreements and concessions that have a profoundly negative impact on your finances.

Wondering what your next step is as you prepare for divorce? It’s time to talk to the team at John H. Ruby & Associates. Call us at 502-373-8044 to set up a consultation right away.

Filing Status and Dependents

One of the first ways you’ll feel the financial effects of your divorce is in your taxes. Your marital status as of December 31 in the year you’re filing for will determine which filing status you select. If you are still married on December 31 of one year but divorce before tax time of the following year, that means you’ll still need to choose married filing jointly or married filing separately. The first exposes you to the potential financially unsound decisions your ex has made, while the latter strips you of the benefits of the married filing status without giving you the benefits of the single filing status.

Figuring out who claims the dependents can be a time-consuming part of the custody battle, especially if either party is likely to qualify for the EITC or other child-related tax credits. It’s common for parents to switch off years, especially if they have a 50/50 custody arrangement. If one parent has primary custody, the court may order them to claim the child every year. If the non-custodial parent pays a significant amount of child support, they may be permitted to claim every other year.

Asset Division

Your division of assets could affect your taxes for the year in which your divorce is finalized. As a general rule, the transfer of property between spouses as part of a divorce is free from tax implications. This protects spouses from capital gains taxes and other unexpected consequences.

You’ll still need to consider capital gains taxes if you receive assets in a divorce. When you choose to sell them in the future, you may be forced to pay capital gains taxes. It depends on the type of asset you have, how long it was in your possession, and if you qualify for any exemptions. If this may be relevant to your divorce, consider speaking with a tax professional as part of your divorce preparations.

If retirement accounts are split during the divorce, you’ll likely use a Qualified Domestic Relations Order to transfer the assets without suffering tax consequences. This allows the receiving spouse to avoid early withdrawal penalties and hefty taxes. Note, though, that this usually only works if the receiving spouse rolls the funds into their own account shortly after receiving them. If they are paid out their share of the retirement accounts and they just keep the money, they may have to pay penalties.

What About Spousal Support and Child Support?

This is an area of significant confusion among divorced and divorcing individuals. Child support is not taxable or tax-deductible. It does not decrease the payor’s taxable income (and therefore their tax burden), nor does it increase the recipient’s taxable income and potentially cause them to lose out on any public benefits they receive.

The same is now true for spousal support. Prior to 2019, the alimony payor could deduct their payments from their income and the recipient could claim the alimony as taxable income. This had benefits on both sides, as the payor could pay less in taxes and the recipient could use their alimony to qualify for certain forms of credit. Support payments are no longer tax-deductible or taxable.

Choose John H. Ruby & Associates for Your Family Law Needs

We know you have a lot of questions regarding your divorce, and we want to make this time as easy as possible for you. Call us at 502-373-8044 or fill out our online contact form—we are ready to talk to you about your options and help you figure out your next steps.