Divorce comes with lots of questions, including questions pertaining to potential tax consequences of dividing or transferring money. The following are seven unexpected tax benefits you may be able to take advantage of during and after your divorce:
- Deduction of spousal support payments to your ex-spouse.
The law for tax deductions on spousal support underwent a change in the enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017. If your divorce agreement was executed on or before December 31, 2018, then you are eligible to deduct money paid to your ex-spouse in spousal support on your W-4. To qualify, the spousal support has to be specified in your divorce agreement and must be made in cash-only payments to your ex-spouse, who must, in turn, report the spousal support payments to the IRS as taxable income. On the other hand, if you are receiving spousal support under a divorce decree entered post-2018, the TCJA states that you no longer have to report your spousal support award as taxable income. It is also important to note that a modification to a pre-2018 agreement that explicitly states the TCJA applies, will then institute the application of the new rule and spousal support payments will no longer be considered a deduction.
- Be aware of your filing status.
If you were not legally divorced during the tax filing year, you may file a joint tax return if you were not divorced as of December 31st. You may also file as married-filing separately, a gain a larger return than you would filing independently. Additionally, you can claim head of household and receive larger return benefits if you have lived apart from your spouse for the last six months of the year, had a dependent living with you for more than half of the year, filed separate returns, and paid more than half of the maintenance of your home.
- Tax consequences of particular asset transfers.
It is important to be aware of particular tax consequences for certain asset transfers. Some assets are significantly taxed upon transfer, like property or stocks. Therefore, an asset such as a bank account may be more valuable in the long run. Be sure to look at the long-term profits of each asset and make your decisions accordingly.
Additionally, the transfer or division of retirement assets may be made pursuant to a Qualified Domestic Relations Order (“QDRO”) which allows for a transfer of retirement assets without any negative tax consequences. Since retirement assets are governed by ERISA, a plan administrator can require and include specific language in a QDRO allowing for a former spouse to receive a portion of the plan participant’s retirement accounts. However, QDRO’s are very technical and complex, and you should consult an attorney to assist in the drafting process to avoid any legal issues.
- Potential solutions to taxes on post-divorce home sale profits.
If you sell your home as part of your divorce, the timing could make a difference in the amount of taxes you avoid paying on the profits. You may be able to reduce or avoid up to $250,000 in capital gains tax you receive if you have used it as a primary residence for at least two years in the last five. If you file a joint tax return, you can avoid paying taxes on up to $500,000. Sales after a divorce depend on whether this two-year test is met. The benefits of this are notable when you think about the sale of your home, even a few years after your divorce, where you are stuck with the $250,000 maximum exclusion.
- Claiming your children on your tax return documents.
Typically, the custodial parent claims the child on their tax return. However, this is not to say that a non-custodial parent cannot claim a child for tax purposes. If the custodial parent signs a waiver or court order agreeing not to claim a particular child on their tax return, then you are free to claim them. Just be sure that both parents are not claiming the same child to avoid sanctions from the IRS.
Often, custody orders will state who is allowed to claim a child on their tax return for a particular year. Parents can get creative, especially when there are multiple children.
- Claiming medical expenses for your children.
Money you pay for your children’s medical expenses after a divorce can be deducted in your medical-expense deductions. You can claim this even if your ex-spouse is the custodial parent.
- Receipt of spousal support as contributing to your IRA.
There is an exception for divorced people to the general rule that a taxpayer must have earned income from a job or self-employment to contribute to an IRA. Any taxable spousal support counts as compensation for purposes of contributions to your IRA. Remember that the rules for spousal support have changed recently, so be aware that spousal support agreements enacted post-2018 are no longer taxed, and therefore, cannot qualify as compensation for IRA contribution purposes.
Navigating through divorce is often overwhelming and confusing. The experienced attorneys at Hicks Crandall Juhl are ready and willing to help answer any questions you may have. To schedule a consultation, contact us here.
 See Internal Revenue Serv., CLARIFICATION: Changes to deduction for certain alimony payments effective in 2019 (Mar. 24, 2021), https://www.irs.gov/forms-pubs/clarification-changes-to-deduction-for-certain-alimony-payments-effective-in-2019.
 See Internal Revenue Serv., Topic No. 701 Sale of Your Home (Nov. 4, 2021), https://www.irs.gov/taxtopics/tc701. However, you may only use this exclusion once every two years. Id.
 See id.