By FPA Members Elaine King, CFP®, CDFA™ and Philip Herzberg, CFP®, MSF
Last Updated: August 1, 2011
Familiarizing yourself with the applicable tax rules and planning issues associated with your divorce settlement may be quite a significant challenge. With the collective expertise of a family law attorney, tax professional, and divorce financial planner, you can address the various tax considerations impacting your divorce settlement and tackle the pertinent financial ramifications affecting your future life planning.
Below is a list of integral insights for direction on handling these diverse tax-related divorce concerns.
Contemplate filing status on your income tax return
- Keeping in mind that your marital status is determined as of the last day of the calendar year, consult with a tax expert to help you evaluate your filing status options. If still married on December 31st of the tax year, you can decide to file a joint return, especially if you can amicably deal with your spouse after the divorce. In this scenario, you should also weigh possible monetary savings and taxation issues when assessing whether to file jointly or married filing separately.
Alternatively, if you became divorced on December 31st, you have the option of filing as a single taxpayer or head of household for that year. Note that you can also be eligible to claim head of household status if you are legally separated from your spouse. To qualify for head of household filing status, you must meet numerous requirements. These requirements include having lived apart from your spouse for the last six months of the tax year, and paying more than half the cost of keeping the primary residence for your child or other qualifying dependents you claim as a tax exemption.
Understand tax implications relating to alimony, child support and custody
- Proactively seek the knowledge of a family legal professional and divorce financial planner with tax acumen to educate yourself about alimony and child support provisions, which vary from state to state. To optimally protect your family’s financial needs, become better versed about the federal tax consequences of spousal and child support. If you receive alimony, you may need to make estimated tax payments or increase your withholding on your wages. Conversely, know that money paid as child support is not income to the recipient and not deductible by the payor.
- For the most part, you can claim your kids as dependents according to divorce decree or if you were designated the custodian by court order. If there is no such agreement, then you can be determined to be the custodial parent if you have physical custody of your child for the greater portion of the year.
As the custodial parent, you are generally entitled to the dependency exemption and tax deduction for your child’s care, as long as you and your former spouse as parents (separately or collectively) account for at least one-half of your child’s support. Be aware that you can consent to release your rights to claim the dependency exemption and tax benefits to the non-custodial parent by filing Internal Revenue Service (IRS) Form 8332.
Outline and evaluate all financial and tax implications related to marital residence and asset disposition
- Should the custodial parent keep the house or should it be sold or assigned to your divorcing spouse? As splitting the house may be harder than splitting up1, you can factor in current economic conditions, capital gains, and post-divorce cash flow to decide whether to retain the primary residence or allot other assets. In concert with divorce attorneys and credentialed tax professionals, substantiate how your property will be partitioned in your divorce settlement, taking into account income taxes and liquidity of your marital homes and other assets.
- Make a checklist of relevant separate and joint account information and previously filed income tax returns. Pursuant to a divorce, recognize that you can utilize a Qualified Domestic Relations Order (QDRO) to distribute a qualified retirement pension or plan assets to your former spouse without generating a taxable event or affecting the integrity of the plan. Be wary that a QDRO can have tax-relevant issues and potential penalties involved with premature distributions.
- Incident to a divorce settlement, understand that you can generally make tax-free transfers of investment assets (i.e. stock options) held in taxable accounts between you and your spouse. Also, think about hiring an independent valuation specialist to appropriately value significant assets, such as a family business during the divorce proceedings.
Orient yourself with these tax perspectives when dividing assets with your divorcing spouse. With the advice of financial and tax professionals experienced in handling divorces, you can carefully plan for your predicament and deal with important decisions.
1 Kelly Phillips Erb’s April 6, 2011, Time Business feature, “Divorce and Taxes: Five Things to Know When Filing Returns.”
FPA member Elaine King, CFP®, CDFA™, is the founder of Family & Money Matters Institute in Miami, Fla. FPA member Philip Herzberg, CFP®, MSF, is Director of Media Relations & Public Awareness for FPA of Miami-Dade.