Learn How Divorce Affects Filing Your Taxes
Individuals may face many changes after a divorce, including changes to the way they must file their income tax return. The most significant change may be to filing status, filing separately and no longer as a married couple. This can impact tax brackets, which may change the overall percentage of taxes divorced individuals pay. It can also reduce the standard deduction afforded to the taxpayer. Depending on employment and earnings this can increase or decrease tax burden.
Taxpayers may still be able to file their taxes as a married couple if a divorce is not finalized by the end of the year. Generally, if you are legally married as of December 31, you can file jointly. This applies even if you are physically separated.
Tax Treatment of Child Custody and Related Issues
Having custody of a child often means that you can claim them as dependents on your tax return. However, a divorce decree may specifically address who can claim the child for tax purposes. The child can only be claimed on one tax return, regardless of his or her living situation. In some situations, a couple may alternate years in which they can claim this tax advantage.
Child support is not a deductible expense for the parent paying it. It is also not considered taxable income for the spouse receiving it. Alimony, however, is treated differently than child support. Alimony must be reported as income, and it can be a tax deduction for parent paying it.
If a parent pays a child's medical expenses and itemizes deductions on their return, they can continue to do so, even after divorce. They can also continue to claim all tax credits associated with the child's care so long as the parent is claiming the child as a dependent on their return. Even if the former spouse is claiming the child as a dependent, the parent not claiming the child may be eligible to deduct childcare expenses when incurred by them.
Property Settlements and Asset Transfers
Dividing property is relatively common during a divorce. These transfers are usually not taxed if the transfer occurs before the divorce is finalized. However, they can still be tricky because when the property shifts, the cost basis also shifts. The cost basis is the property's "worth" for tax purposes. Usually, it's the amount of money that you could get for the property if you sold it on the open market (see a more complete definition here).
Property that may be valued at a certain amount may not realize the full value when sold because of the taxes. For example, if you receive property in a divorce that is valued at $10,000 and the basis is $2,000, you will be taxed on the increase in value of $8,000. At a rate of 15%, the taxes would be $1,200. This makes the true value of the property $8,800 as opposed to $10,000.
Note: Married couples filing jointly are eligible for a tax exemption on the first $500,000 in gains from the sale of a primary residence, where as, individuals are taxed on gains over $250,000.
Q&A: What filing status should I choose if I'm in the middle of a divorce?
If the divorce is not finalized, you have the option to file jointly. Typically, this will be the most advantageous filing status and result in the largest refund or smallest tax amount owed. With that said, filing jointly will require you to work with your spouse and in the case of a refund, determine how to split it. If there is animosity between your spouse and yourself, it will likely be easier to file separately.