Divorces are difficult – and expensive!
Don’t make yours even more costly by making your settlement final before consulting the Accountability Services tax team.
Once you sign, it’s too late
We often hear clients lament an extra-large tax bill that could have been easily avoided with simple changes in their divorce settlement.
While working together with your soon-to-be ex can sometimes be challenging, when it comes to tax efficiency, cooperating is in both parties’ financial best interests.
Navigating your change in filing status
It’s important to understand that the IRS determines your marital status on December 31. This means that if your divorce is finalized on December 30, you will not be able to file jointly for this tax year.
If you are separated but still legally married on December 31, you still have the option to use married filing jointly status, as long as both parties agree.
Note: Filing jointly may or may not be the right choice for your situation, but speaking with a CPA prior to deciding definitely is.
Implications of reverting to single tax filer status
Once your divorce is finalized, both spouses automatically revert to single filer status for the full tax year (one spouse may qualify for Head-of-Household).
This change impacts:
- Tax rates
- Standard deductions
- Itemized deductions
- Available tax breaks
Depending on you and your ex-spouse’s relative incomes, you could see a significant increase in your tax bill with no other changes in your finances outside of getting divorced. If your W-4 withholdings were never adjusted to reflect your new filing status, you could owe come tax time.
IRA payments under a Qualified Domestic Relations Order (QDRO)
If you or your ex-spouse are entitled to the portion of the other’s retirement plan account balance under a QDRO, there are important tax rules you need to be aware of:
- Payments must be included as income unless they are rolled over into a traditional IRA and meet certain conditions
- Taxable payments are exempt from the 10% early distribution tax
Additional IRA-related tax implications include:
- If you are no longer legally married at the end of the tax year, you cannot deduct any contributions made to your ex-spouse’s traditional IRA during the entirety of that tax year
- Assets can be transferred tax-free from one spouse’s IRA into the other’s under a divorce or separate maintenance decree – note that taxes due upon withdrawal are the responsibility of the party receiving the transfer
- Funds withdrawn from a traditional IRA to pay part of a divorce settlement are taxable to the payer – if the payer is under age 59½ with no qualifying exceptions, a 10% early distribution tax also applies
Take a proactive approach to divorce tax planning
Planning ahead for your change in tax liability is the best way to avoid owing an extra payment come tax time.
Be sure to do the following (if applicable) before signing your divorce agreement:
- Adjust your W-4 to increase your tax withholding
- Determine which partner will be claiming dependents
- Discuss whether the custodial parent or noncustodial parent will claim child tax credits
- Decide whether your primary home will be sold within two years of the divorce in order to qualify for the maximum gain exclusion
- Note that a change in the tax law makes alimony and child support payments for any divorce settlement executed after 2018 non-deductible and the recipient does not need to count these payments as taxable income
- Find out if you must report any property transferred as part of the divorce agreement
- Double-check the tax implications of any necessary IRA-related transfers
Tax strategy guidance for your upcoming divorce
Our team believes a tax return should be the result of strategic planning, and never a surprise. By working through your unique situation and understanding your current and future goals, we can help you successfully navigate divorce with as little tax burden as possible.
Start your journey to tax-efficiency by requesting a free consultation with our team here: online contact form.
