Tax-Related Issues to Address During and After Divorce

 Posted on May 10, 2023 in Divorce

Getting a divorce can be a challenging process that will involve many complex concerns that must be addressed and resolved. Many of these issues are financial in nature, and they may be related to the property you own, the debts you owe, and the income earned by you and your spouse. As you work to negotiate a settlement, you may focus on your immediate needs and desires, including determining how living arrangements will be handled, making sure you have the resources needed to support yourself, and working out child custody arrangements. In the midst of addressing complicated legal issues and emotional concerns, tax-related concerns may be overlooked.

While few people want to think about taxes, it is important to make sure they are considered properly during the divorce process. The decisions made during the end of your marriage can have a significant impact on your financial future. To ensure that you are properly prepared to address tax issues, you can work with a divorce attorney at Weiss-Kunz & Oliver, LLC. With our experience representing clients in complex divorce cases, we can advise you on the tax concerns that may affect you and the options you may have for resolving these issues and protecting your financial interests.

Tax Filing Status

One of the first issues to address during your divorce will be related to how you will file your annual tax returns. While it may be difficult for you and your spouse to cooperate, it may be beneficial for both of you to continue to file taxes jointly prior to finalizing your divorce. Married couples who file jointly may be able to utilize a higher standard deduction and lower the total amount of taxes they will be required to pay.

It is important to understand that you will only be able to file taxes jointly if you are still legally married at the end of a tax year. In the year that your divorce is finalized, the option to file jointly will no longer be available. For example, if your divorce decree or judgment is issued on September 1, 2023, you and your spouse will not be able to file a joint tax return for 2023. However, if your divorce is finalized on January 1, 2024, you will still be able to file taxes jointly for 2023.

When filing taxes jointly, it will be crucial to make sure all information is reported properly. You and your soon-to-be-ex-spouse will both need to provide W-2 forms that report the income you earned in a year, and you can also include any other information that may allow you to claim credits or deductions. You will also need to make sure you understand how to address tax refunds or taxes owed. If you will be receiving a refund, you may agree that it will be divided evenly between the two of you, or you may reach other agreements in your divorce settlement. If you will owe taxes, your divorce settlement may specify how much each of you will be required to pay.

After finalizing your divorce, you will need to determine your filing status going forward. This may depend on decisions about child custody. If you will have at least one dependent who will be living with you for more than half of the year, and you pay more than 50 percent of the maintenance expenses for your home, you may file as head of household, which can provide you with significant tax savings. Otherwise, you will need to file as single. However, if you remarry in the future, you may begin filing your taxes as either married filing jointly or married filing separately.

Taxes Related to the Division of Marital Property

Property division is a fundamental aspect of divorce, and it can have major tax implications. Different types of property may be subject to different tax treatment, and it is crucial to understand how ownership of certain assets may affect the taxes you will be required to pay. You may also need to consider how selling assets during your divorce may affect the taxes you owe.

In general, transfers of assets between you and your spouse during your divorce will not require you to pay taxes. However, if you choose to sell certain assets during your divorce, such as investments or cryptocurrency, you may be required to pay capital gains taxes. If you decide to sell a home that served as your primary residence for at least two of the previous five years, a certain amount of the profits you earn from the sale may be excluded from capital gains tax. When filing as a single person, you may exclude $250,000, and when filing as a married couple, you may exclude $500,000. With correct planning, you may be able to avoid taxes on the sale of your home and ensure that you have the financial resources you need to find new living arrangements.

Additionally, when addressing issues related to property division, it is essential to consider the tax consequences of debt that may be associated with different assets. For example, if you will be maintaining ownership of your family home, you may be able to take advantage of mortgage interest deductions and property tax deductions. Similarly, transferring assets with associated debt, such as credit card debt or car loans, can have tax implications that should be carefully considered.

Taxes on Retirement Accounts

It is also important to understand how taxes may apply when dividing retirement benefits. If either you or your spouse have accounts where you have saved money for your retirement, you may need to divide the funds in these accounts or transfer money from one account to another. However, with an account such as an IRA or 401(k), the money in these accounts is usually tax-deferred. Since funds were deducted from income before applying taxes, the account holder will be required to pay taxes when distributions are received from the account. In addition, since the money in these accounts is meant to provide for a person's needs after they retire, a 10 percent penalty will usually apply if funds are withdrawn before the account holder reaches retirement age, which is usually 59 1/2.

To transfer funds without incurring taxes or being required to pay penalties, you can use a Qualified Domestic Relations Order (QDRO). A QDRO is a court order that allows an alternate payee to receive payments from certain types of retirement accounts, such as a 401(k). When a QDRO is issued, it will instruct the administrator of the retirement plan to deduct a certain amount from the account (either a specific dollar amount or a percentage of the funds) and transfer them to the alternate payee.

For an individual retirement account (IRA), a QDRO may not be used, but a similar procedure known as a "transfer incident to divorce" may be performed. By providing the administrator of the account with a copy of your divorce decree that specifies how the funds in the account will be divided, a tax-free withdrawal can be made from the account, and the funds can be transferred to the account holder's ex-spouse. With a QDRO or a transfer incident to divorce, the party who receives the funds can roll them over into their own IRA or 401(k), and they will not be required to pay taxes until they begin receiving distributions after their retirement.

Tax Issues Related to Family Businesses

If either you or your spouse own a business, you will need to consider the tax implications of maintaining ownership of the business, transferring ownership, or selling the business. As with other types of marital property, transfers of business assets between spouses generally will not require taxes to be paid. However, if a business is sold during the divorce process, capital gains taxes may apply to the profits earned.

If you will be maintaining sole ownership of a family business, you will need to consider the taxes that will apply to the business's revenue and profits. Depending on how the business is structured, corporate taxes may need to be paid, or the profits earned by the business may be "passed through" to you and reported as your personal income. In these situations, you may be able to take advantage of tax deductions.

As a business owner, you may also be able to claim a variety of business deductions, which can provide significant savings. Business deductions are available for certain types of expenses, and they may include anything from rent and utilities to business travel and meals. Keeping accurate records of these expenses is important to ensure that you can take advantage of all the deductions available to you.

Child Tax Deductions and Credits

Decisions about child custody can have a significant impact on your taxes. If you will have primary custody of a child, you will generally be able to claim a deduction on your taxes, and other tax credits may also be available. For example, a child care tax credit may be used for expenses paid to provide care for your child, such as tuition at a daycare center or the costs of hiring nannies or babysitters.

In general, when a child lives with one parent for the majority of the year, that parent will be able to claim the child as a dependent. Because of this, decisions about parenting time can have a significant impact on taxes for you and your spouse. If you have multiple children, you may be able to reach agreements with your spouse regarding who can claim them as dependents. For example, you may each claim one child as a dependent, or you may alternate who can claim children as dependents each year.

Post-Divorce Tax Planning

After finalizing your divorce, it is important to review your tax planning strategies to ensure that they reflect your current situation. You may need to adjust your withholding allowances to ensure that the correct amount is being withheld from your income. If you fail to do so, you could end up owing taxes when you file your annual tax return. By understanding whether you are eligible for certain tax credits or deductions, you can make sure you will be prepared to file taxes correctly in the future. Keeping accurate records of child support or spousal support payments and other transactions can make tax filing simpler and ensure accurate tax reporting.

Contact Our DuPage County Divorce Lawyers for Tax Planning

Divorce can be a complex process, and many of the decisions you make as you work to end your marriage will have significant tax implications. By working with accountants or other tax professionals, you can understand how your taxes will be affected, and with the help of a skilled lawyer, you can ensure that you are making informed decisions as you work to finalize your divorce. At Weiss-Kunz & Oliver, LLC, we can help you minimize the stress and financial burden of tax-related issues during and after your divorce, and we will work to ensure that your interests will be protected. Contact our Elmhurst property division attorneys to learn more about how we can help you address tax-related concerns. Call 312-605-4041 to arrange a consultation today.

Sources:

https://www.bnymellonwealth.com/insights/eight-critical-tax-considerations-for-divorcing-couples.html

https://www.irs.gov/newsroom/some-tax-considerations-for-people-who-are-separating-or-divorcing

https://www.forbes.com/sites/heatherlocus/2022/05/20/critical-tax-facts-in-divorce/