Nothing can be said to be certain, except death and taxes. Another certainty is the fact that when you get divorced you will have to think about how your divorce will change how you approach your taxes. Luckily, this year, your taxes have been automatically postponed until July 15th, 2020, courtesy of COVID-19. As a result, you have plenty of time to figure this out.
Some things to consider when you decide to tackle your taxes:
- If you are divorced before the end of the year you will not be able to file your tax return jointly with your former spouse.
- Property transferred incident to the divorce is not taxable. Whether something is transferred “incident to divorce” is largely a temporal thing: is the transfer contemplated in the divorce or legal separation orders or agreement, and how long after the divorce or legal separation does the transfer occur?
- Qualified retirement plans such as 401(k)s and qualified pensions can be transferred provided that there is an order, known as a Qualified Domestic Relations Order or “QDRO”, permitting the transfer. Most IRAs don’t require a QDRO, although I have run across a few IRA vendors who require one.
- After the divorce, the five tax goodies associated with having children are generally divided based on who gets the most overnights with the kids. Those tax goodies are: the Dependency Exemption (largely meaningless and reduced to $0 since the Tax Cuts and Jobs Act of 2017), the Child Tax Credit, Head of Household Status, the Dependent Care Credit and the Earned Income Credit. While the Dependency Exemption and the Child Tax Credit may be traded between the parties using the Form 8332, eligibility for Head of Household status, the Dependent Care Credit and the Earned Income Credit are always allocated to the parent who has the most overnights with the children.
- Your Separation Agreement should include language allocating tax liability in the event that you are audited for a jointly-filed return in a prior year.
- There is generally no step-up in basis in divorce. The spouse receiving property receives it with the same basis as existed during the marriage.
- Ask your attorney to talk to you about how losses should be divided in the divorce. Losses may have considerable value in offsetting future income and some of them can roll forward from year to year, either in whole or in part. Some losses to consider include passive activity losses, net operating losses from a business, capital losses, investment interest expenses and even charitable contributions.
- If there is a rental property or a business asset in your divorce that will be converted to personal use, there may be significant tax ramifications for the recipient spouse as he or she may be required to recapture the depreciation previously taken.
While this list is not exhaustive, it does highlight some tax traps for the unwary. Be sure your counsel is well versed in tax issues before signing on the bottom line in your divorce.