Attention Divorcees: Here’s How Your Settlement Might Impact Your Taxes
(ConservativeInsider.org) – When couples divorce, they’re often focused on how it will affect their daily lives, including finances. Yet how taxes might impact a divorce settlement might not immediately occur to either former partner.
Fortunately, the division of property and payment transfers made as part of the divorce settlement generally aren’t subject to taxation these days. Still, former couples should be aware of a few exceptions that exist.
Let’s look at a few of the typical kinds of settlements.
Property Settlements
In most cases, former spouses don’t owe taxes on any properties transferred as part of the divorce settlement or up to one year after the marriage ends. Title 26 of the US Code, Section 1041(a) forms the basis for the tax-free exchange of property between spouses while married or during a divorce.
So, for instance, the custodial spouse could buy the other out of their share of the family home to allow the children to continue living in the house to experience the least disruption. Money received for the non-custodial spouse’s share of the home wouldn’t count as income or be taxable. Instead, the IRS treats the transfer as a non-taxable gift.
Extending the example, the custodial spouse would become responsible for all property taxes after buying out the former spouse. Additionally, should the home increase in value from either the original purchase or the buyout and the custodial spouse decides to sell the home, taxes on any capital gains above the $250,000 IRS-qualified-exemption would become the sole responsibility of the custodial spouse.
Any properties the former spouses continue to own jointly after one year are subject to taxation if they decide to liquidate or transfer those properties after that time.
Another statute that guides taxation is Title 26 of the US Code, Section 2516, which allows couples to enter into a three-year agreement regarding their divorce up to one year before filing for divorce. The contract might provide for spousal maintenance and child support tax-free. So, during a legal separation that could potentially lead to divorce, there could be spousal and dependent support, neither of which would count as taxable income.
Alimony
In some divorces, one former spouse might make considerably more income than the other. Sometimes, the court will order the person earning more to make payments in the form of alimony to the former spouse for a while or until the former spouse remarries. For divorces finalized on or before Dec. 31, 2018, payors could deduct alimony from their taxes, while those who received payments had to declare it as taxable income to the IRS.
When judges order alimony in divorces finalized on or after January 1, 2019, payors can no longer claim deductions for alimony payments. Individuals receiving alimony payments no longer have to report them as income to the IRS. Changes in status or amendments to divorce agreements after January 2019 often result in the update of the rules as well.
Other Types of Support
Alimony might not be the only type of payment an ex-spouse makes. Others include child support, medical expenses, and even voluntary payments. Typically, the government doesn’t tax recipients on any of these payments, but the payor can’t take deductions for any of them, either. One exception might be medical bills for dependent children, which are deductible if they exceed 7.5% of the payor’s gross income, according to the IRS.
Divorce can be tricky legally, emotionally, socially, and financially. It’s best to hire experienced pilots to navigate dark waters knowing there are plenty of obstacles. Most people immediately hire the best attorney they can afford to handle a divorce, but hiring a financial advisor could be just as important in the long run.
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