Tax Planning for Divorce

If you are getting a divorce, taxes are probably not highest on your list of concerns. Still, you should consider a number of tax-related issues.

Property Settlements

Dividing property in connection with a divorce generally has no immediate consequences for either spouse. However, if the spouse who receives property in the divorce settlement later sells it, there may be a gain to report for tax purposes. So, potential taxes should be a consideration in deciding which spouse will receive which property.

Note that a spouse who receives property in a divorce figures any gain on a subsequent sale of the property using the transferring spouse's basis (e.g., cost), not the property's value when it was received.

For example: Michelle receives 10 acres of unimproved land in her divorce settlement. Her ex-husband bought the land for $25,000. It's now worth $100,000. If Michelle sells the land for $100,000, she will have to report a taxable gain of $75,000 (the difference between the $100,000 selling price and the $25,000 cost basis).

Personal Residence

If a divorcing couple sells their home while they are still married, they are entitled to exclude up to $500,000 of gain from their taxable income if otherwise eligible for the exclusion. If the ownership of the home is simply transferred to one spouse as part of the divorce settlement, there is no taxable gain or loss at the time of transfer. However, should that spouse later sell the house while he or she is unmarried, only a $250,000 exclusion would be available.

Retirement Benefits

A divorce settlement often determines how retirement plan benefits will be divided. However, an employer may distribute retirement plan benefits to a former spouse only after receiving a court-issued document that meets the requirements for a qualified domestic relations order (QDRO). The benefits are taxable to the former spouse who receives them pursuant to a QDRO.

Dependency Exemptions

The Tax Cuts and Jobs Act of 2017 suspended the deduction for dependency exemptions for 2018 through 2025. But after 2025, the deduction will apply (unless additional changes are made). While the spouse who has legal custody of a child is generally entitled to claim the dependency exemption, this tax advantage is negotiable and can change from year to year. The custodial spouse can waive his or her right to the exemption, allowing the noncustodial spouse to claim it.

Other Tax Benefits

Having a child qualify as a dependent may impact other tax benefits. For example, there is a potential child tax credit of up to $2,000 annually for each qualifying dependent child under age 17.

Alimony vs. Child Support

Under the Tax Cuts and Jobs Act of 2017, a tax deduction is no longer available for alimony payments made under post-2018 divorce or separation agreements and recipients are not required to include the payments in income. Previously, payments that qualify as alimony under tax law were deductible by the paying spouse and considered taxable income to the recipient spouse.

These are just some of the tax planning issues that could be important in a divorce situation. Be sure to consult your tax and legal professionals to discuss how these general rules pertain to your personal situation.