Taxes affect every aspect of our lives, including divorce. Whether you can file a tax return together, your filing status, whether you can deduct alimony payments, tax consequences of property transfers and a host of other issues are determined by your divorce judgment or orders and the tax code. And the tax law changed in critical ways in 2018. Understand how these changes to our tax law may affect your divorce.
Alimony and Taxes
How has the tax law change regarding maintenance (alimony) in 2019?
Tax law around the nation changed in 2019. For divorces and written separation agreements since year-end 2018, spousal support is no longer deductible for the party paying it. Nor does the recipient have to include maintenance (alimony) in her (or his) income for divorce entered on or after that date. This is an over-simplification of this critical change in the law. It significantly impacts any divorce, especially involving Illinois divorces cases because of the Illinois maintenance guidelines.
I pay maintenance payments to my former spouse. May I deduct the maintenance?
It depends. For divorces entered before 2019, the payor deducts maintenance (alimony). And for these divorces, payments are included in the income of the person receiving them. To be able to deduct the maintenance payments for the payor, there were several requirements. This included:
- The payment must be in cash, or its equivalent, such as a check;
- The payment must be required under a divorce or written separation agreement;
- The maintenance must terminate upon the death of the payee.
- Payments that are ordinarily deductible are not deductible if the divorce decree specifically states that the payments are not alimony/maintenance and/or non-deductible.
For divorces entered after 2018, no longer can the payor deduct maintenance. Yet maintenance remains deductible—even if modified—as long as the underlying divorce or written separation agreement predated January 1, 2019.
Submission of Joint Tax Returns
I am currently in divorce proceedings. Can I file jointly with my spouse?
Yes. If a final judgment of divorce has not been entered by December 31, you are considered married. You can file a joint return.
Can we, for the year in which we are divorced, file a joint return?
No. You must be married on the last day of the year (December 31) to file a joint return. You can go through with the divorce hearing before December 31, but wait to finalize the divorce (entry of the final judgment) until January. In such a case, you can file a joint return for the previous year.
We have an income tax refund on account of last year’s tax returns. Who gets the refund?
If you filed joint returns for the previous year, the refund check should be made out to both of you. The marital settlement agreement or divorce judgment should state how you and your spouse will receive or divide the income tax refund check. But it’s more complex than that. Review any electronic filing to determine if it provides for an auto deposit into a certain account.
I believe my spouse’s tax return is not honest. Must I file jointly?
No. You are able to file as head of household if you did not live with your spouse for the last six months of the tax year and meet the other head of household requirements. If not, then you may file as married filing separately.
Exemptions and Credits Related to the Children
What is a personal exemption and how has the tax law changed?
A personal exemption is a deduction reducing taxable income. Through to 2017, you could claim one exemption for each dependent you claim. But through to 2025 no longer are dependent exemptions a deduction on tax returns. On the other hand, this ties in with the child-tax credit discussed below. This law is complex and advice of a lawyer is critical to protect your rights.
I am divorced and the “custodial” parent. The divorce judgment does not address who can claim the children as exemptions. Can I claim the child tax credit?
Yes. Under current tax law through to 2025, no longer is there any value to the exemption itself. But the value of the child tax credit increased from $1,000 to $2,000 per child. Its allocation “follows” the allocation of the children as dependent exemptions.
Can I still claim the child tax credit if I signed IRS Form 8332, waving the exemption?
Probably not. IRS Form 8332 is a statement by the primary residential parent releasing the exemption—and with it the child tax credit. If the primary residential parent signs Form 8332, then only the non residential parent should be able to claim the child tax credit.
Can I claim the tax credit if the marital settlement agreement or the divorce judgment gives the exemption to my spouse?
Yes and no. The party given the exemption in the marital settlement agreement, or the divorce judgment, is entitled to the exemption and you could be held in contempt of court if you claim the exemption. Yet the IRS takes the position the custodial parent has the right to the exemption if that parent has not waived the right via the 8332 form.
What is the child tax credit?
The child tax credit is a $2,000 credit against the tax owed. It is available to parents with children either under 17.
As the custodial parent, what other tax credits might I qualify?
The primary residential parent only can claim the child and dependent care credit. This is true regardless of which parent claims the tax exemption for the child. This credit is available if your child is under 13 and you pay child care expenses in order to work or seek work.
What tax consequences arise when property is distributed by a divorce judgment?
The general rule is that no gain or loss is recognized at the time of the transfer when property is transferred to a former spouse, so long as the transfer is incident to divorce. To be “incident to divorce,” the transfer must occur within one year after the divorce judgment’s entry or the transfer must be related to the cessation of the marriage.
There are so-called “Temporary Regulations” that flesh out this law, even though those regulations are not really temporary. Those regulations further define the term “related to cessation of the marriage” to be a transfer pursuant to a divorce or separation instrument, if the transfer occurs within six years after the date on which the marriage ceases.
Be mindful of any transaction between the spouses during this six-year time frame. An IRS private letter ruling, involved a husband who was awarded a right of first refusal to acquire the family home that was awarded to the wife. This right of first refusal was exercised within the six-year time frame, and the former husband “purchased” the home from his ex-spouse. The IRS indicated that it was not a purchase and sale but a nontaxable transfer under Sec. 1041. This resulted in the wife’s receiving nontaxable cash from the “sale” of the home and the husband’s receiving the home with the wife’s basis.
Also keep in mind that the assets have what’s called a “carryover basis.” In a nutshell this means that the potential tax liability has only been deferred. Looking at the potential tax liability of all the assets that are being divided from the marital property is important to make the asset division more equitable. It also eliminate potential surprises for the parties later.
Are distributions from a pension plan taxable?
Yes, but the tax may be avoided by a rollover to an eligible retirement plan. In many divorces one spouse’s retirement plan is one of the most valuable assets in the marriage, and the other spouse may be awarded part of the retirement plan.
There are several options the recipient of a part of a retirement plan can exercise.
- The first option should be avoided if at all possible and involves a cash out the distributive interest in the retirement plan. A cash out means you will pay income tax on the entire amount of the distribution plus a 10% early withdrawal penalty.
- The second option, under which you pay no tax or penalty, is to cash out your interest in the retirement plan, then roll it over into another eligible retirement plan, such as an IRA: The rollover must take place within 60 days for the distribution to be tax-free.
- The third option is to take your interest in the form of a Qualified Domestic Relations Orders (QDRO). Under a QDRO, the pension plan administrator must carve out for you your interest in your spouse’s pension plan, and you will have the same rights in regard to the pension plan as does your spouse. The rollover into another qualified plan is tax free. See the Gitlin Law Firm’s Q&A regarding Retirement Plans and Divorce. There is generally a one-time right to avoid the early withdrawal penalty and take a cash distribution (that will be subject to regular income taxes).
We may have to sell the marital residence as part of the divorce settlement. Is the gain from that sale taxable?
Yes. However, gain from the sale of a property is excluded from income if it was owned and used as the taxpayer’s primary home for two of the last five years. (This is known as the use and ownership test). This exclusion is limited to $250,000, or $500,000 in the case of a joint return. On a joint return, the taxpayers can exclude the full amount as long as one spouse meets the ownership requirement and both spouses meet the two year use requirement.
To meet these requirements, the taxpayer will be treated as using the property as a primary residence during any period that their spouse or former spouse is granted use by a divorce or separation agreement. See the IRS discussion of this topic that explains things well.
Where else can I go to find answers to my tax questions?
The income tax consequences of a divorce, especially one involving substantial income and/or substantial assets, are legally complex. You should receive advice from a lawyer who is divorce-income tax knowledgeable, or an accountant.
Updated: July 2023