Filing income taxes can be stressful, and figuring out all the details of your return during and after a divorce only complicates matters further. In addition to changing your filing status, you’ll need to determine who will claim any children as dependents and be eligible for child related credits. Taxes on the sale of a home or other assets may come up, and penalties may be due on any retirement accounts that were separated if you failed to complete a Transfer Incident to Divorce or a Qualified Domestic Relations Order (QDRO). Spousal support is considered a form of taxable income, but if you are the spouse paying support, you’ll be eligible to claim those payments as a tax deduction. Due to the complex nature of income taxes, it is highly advisable to work hand-in-hand with a certified public accountant (CPA) and/or your divorce attorney to ensure you are receiving every tax benefit owed to you.
Choose the Appropriate Filing Status
Depending on whether your divorce was finalized before the last day of the tax year, you and your spouse may have the option to file as married for one additional year. You may also choose to file as “married-filing-separately,” but this status typically results in higher payments to the IRS. Once your divorce is complete, your filing options will become “single” or “head of household” (unless you remarry right away). People eligible for the head of household status must cover more than half of all expenses associated with the household and must also have had a dependent living in the home for more than half of the year. If you are eligible to file as head of household, you’ll receive tax breaks that can save you significant amounts of money when compared to the single filing status.
Determine Who Will Claim the Children as Dependents
Claiming a child as a dependent on your income tax allows you to receive significant tax breaks. Keep in mind, however, that only one parent can claim each child per year. Typically speaking, the custodial parent claims the children, although spouses are free to create an alternate arrangement if they so choose. Some couples prefer to alternate years claiming the children, while some non-custodial parents claim the children every year (provided the custodial parent formally agrees to this arrangement). The parent who claims the children may also be eligible to receive the child tax credit as well as any education-related credits, while either parent may be eligible for work-related and/or medical credits if childcare and/or medical expenses were paid for any children involved.
The Sale of Assets May Incur Taxes
As you are dividing up marital assets it is important to keep in mind any potential taxes which may be due upon sale of the property. Capital-gains tax, for example, may be owed if you and your spouse sold a home that appreciated more than $500,000 since the initial purchase (normally, the tax is due when a home has appreciated more than $250,000 in value, but married couples are granted a $250,000 exclusion for each partner). In order to qualify for this tax exemption, you and/or your spouse must have lived in the home for at least two of the last five years. Additional assets, including stocks, will also be taxed when they are sold and rarely have exemptions as generous as the sale of a home, so be sure to subtract the cost of these taxes from the value of the assets before completing the final version of your divorce decree.
Avoid Taxes on Retirement Accounts
Couples that choose to separate one or more retirement accounts during a divorce will need to carefully plan in order to avoid paying taxes on the transfer, as well as early withdrawal penalties (for people that have not reached retirement age). All or a portion of your IRA can be transferred to your spouse without undesirable financial consequences by creating a Transfer Incident to Divorce that will be added to your divorce settlement. 403(b)s, including qualified 401(k)s, must be separated with a QDRO to avoid taxes and penalties. With proper planning, spouses receiving a portion of the couple’s joint retirement account(s) will be eligible to roll this property over into a new retirement account without additional expense.
Spousal Support is Taxable and Can be Claimed as a Deduction
Unlike child support payments, which are not considered a form of taxable income, spousal support must be included by the recipient when determining the total amount of income tax due each year. If you are the spouse who pays spousal support, you will be eligible to claim those payments as a tax deduction even if you choose not to itemize deductions. It is important to note, however, that you must have your spouse’s social security number and a formal payment arrangement outlined in your divorce settlement in order to qualify for this deduction.
Maximize Your Return or Minimize Your Tax
Income taxes are so detailed that many people choose to hire a CPA to complete these forms on their behalf every year. Getting a divorce only complicates matters and it often takes a few years for couples to adjust to their new credits, deductions, and more. Without care, many people face the very real possibility of missing out on a number of money-saving tax tricks that may only be known and/or understood by professionals. If you have recently gone through a divorce, working with a CPA and/or your divorce attorney is a smart way to ensure you receive your maximum refund or pay the smallest tax amount possible.
The experienced legal team at the Law Offices of Silky Sahnan can support and guide you in all matters of your California divorce. We strive to provide clients peace of mind and reassurance that their investments and best interests will be protected. Call us today at 888-228-1098 for a confidential consultation.