Posted by James Financial Services Inc

Critical Tax Considerations for all Divorcing Couples

Critical Tax Considerations for all Divorcing Couples

Divorce is a nightmare and messy process that people try to do away with as soon as possible. They hardly consider consequences on taxes, especially in the long run. Most times, it is a painful and emotional process that leaves no space to consider taxes. 

Sadly, poor tax planning could lead to more problems for the parties later on. Some issues will not arise until years later, and such could pose a severe headache.

By putting these essential tax issues at the brink of the negotiation process, you can avoid serious problems down the line. This way, splitting couples can go their separate ways without feeling tied to their past. 

With this, here are essential tax considerations for couples:

  1. Choosing the best time to Finalize Such Divorce

There are times in which if you wait until after the last day of the year, you get more tax benefits. This applies more to a couple in which one spouse earns way more than the other because single filers might translate to a higher tax bill as single filers have a more stringent tax bracket than couples filing jointly. 

On the other hand, for couples in which both spouses earn significantly, joint filing could catapult them to the highest tax bracket, while separate filing would not.

  1. Deciding who gets the tax Credits 

Two people cannot claim a dependent which makes it essential to understand Uncle Sam's criteria for deciding who gets the credit. As a rule, the parent who receives the child's physical custody mainly in a year is qualified to claim the Child Tax Credit. 

In some cases, however, the credit is better claimed by the non-custodial spouse. Also, there is a possibility of arranging the divorce agreement to alternate who gets the credit every year.

  1. Understand Adjustment to the tax treatment of Alimony Funds

The 2017 TCJA got rid of many deductions for previous expenses that could be deducted. With this, all divorce agreements settled after 2018 cannot have the alimony as a deduction for the paying spouse, and the recipient also will not be taxed on it. 

This arrangement, however, does not hold for spouses paying alimony established before Dec 31, 2018.

  1. Decide on the best Approach for property Transfer 

All the transfer of property done during divorce is classified as non-taxable for gift and federal income taxes. 

In some cases, however, it could be good to ignore the tax-free advantage that the law gives divorcing spouses when transferring properties. Instead, it could be best to have a taxable event by making the transaction a "true sale" more than a year after the divorce. With this, the spouse who bought the ex-spouse's share could gain from an increased cost of the property.

Also, bear in mind that for the sale of a personal residence used as a principal residence, which spanned up to two years from the five years, it is possible to exclude as much as $250,000 for single filers (double amount for double filers) from the tax for capital gains.


  1. Know What tax Carryover Means 

In negotiating the division of assets and liabilities, tax carryovers such as passive activity loss, capital loss. Charitable deductions and net operating losses are treated to have inherent value like property.

It might not make sense to discuss their allocation during tax time but in the negotiation period, like your other assets.


  1. Transfer of Retirement Assets 

For you to transfer all or a portion of a retirement plan that qualifies as involved in the divorce settlement process, the court needs to give out a qualified domestic relations order (QDRO). It does not come with tax consequences should the transfer be classified as an eligible rollover distribution. 

When you get a part of your ex-spouse's retirement account with the QDRO, the receiver must decide if they want it in the existing plan or if they prefer rolling it into an IRA. 

QDROs do not control the transfer and division of IRA assets. One can, however, transfer IRA dollars via a direct transfer without any tax penalty, provided the transfer has to do with the divorce. To derive tax exemption and avoid penalties for early withdrawals, these transfers need to be guided by IRS regulation. 



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