Tax and Divorce

Yes, you really have to think about taxes as part of your divorce. There can be significant tax ramifications resulting from a divorce. Depending on your situation, some tax issues can be quite complicated. Therefore, good divorce planning includes good tax planning.

A divorce will affect your taxes in several respects, including your tax bill when you file, and payroll withholding and/or estimated taxes. Different tax tables apply to unmarried persons instead of married persons, selected based on their marital status on December 31. Additionally, persons with different incomes may end up in different tax brackets and differing income tax brackets can affect budgets and cash flow. Spousal maintenance (alimony) is usually (but not always) tax-deductible to the paying spouse and treated as income to the recipient, so long as certain rules are followed. If the rules are not followed as part of the divorce, there might be an unpleasant surprise and the tax-effect of the alimony as part of the divorce settlement may be different. However, child support and property division normally have no direct income tax effect.

An important consideration is that different types of property come with different tax considerations that may affect their economic value, and which may affect how you view your divorce settlement. For example, property with a low cost basis (purchase price plus allowed costs of improvements) will likely come with a future tax bill that will come due when the property is sold for a profit. Similarly, retirement plans, IRAs, and similar tax-deferred assets come with future tax obligations that may affect how you view them. Some types of property, such as various types of options, can have very complicated tax considerations following a divorce. Finally, head of household status and dependency exemptions may affect each spouse’s finances.

Many of the variables can be considered and addressed in your divorce, so that you and your spouse can take maximum benefit of what is allowed under the tax laws. Divorce tax planning can therefore be an extremely important part—though a sometimes overlooked—part of the divorce process.

A good divorce lawyer can advise you about many of the tax issues that pertain to divorce. Some tax issues are complicated and technical, however, and may require advice from a qualified tax specialist. The investment in good tax advice will usually more than pay for itself.