A Divorce Settlement Can Protect Your Finances and Make Tax Filing Easier
Divorce and taxes, which usually aren’t anyone’s favorite topics, can be even worse when they’re brought together. However, if you’ve recently finalized a divorce or are about to go through one, you’ll have to face the fact that tax issues are definitely going to come up. This is because your financial lives have also been married and will remain so for some time, especially if you have young children. Here are some points to consider:
Alimony and child support: Alimony is usually taxable for the person who receives it and is deductible for the person who pays it, while child support is neither taxed nor deducted. It can be stipulated in the divorce decree that payments to an ex spouse are not considered as alimony. So, make sure you know what’s written in the settlement agreement, even if you’d rather forget the details and the whole process. Otherwise, the first time you file taxes after a divorce, you’ll find it more complicated than you’ve anticipated.
If you're paying alimony, you don't need to itemize to claim the deduction and can simply take it on Form 1040. If you're receiving it, you'll likewise report it on Form 1040, and yes, you may have to pay estimated taxes.
Dependency exemption: Generally, the parent who has the most custodial time with the children takes the exemption. However, the settlement agreement can be written to accommodate both parties – e.g. the mother claims it in even numbered years and the father takes it in odd numbered years. Pay attention to this detail when negotiating your divorce and remember that it will be important when it’s time to file your taxes.
Division of property: Who gets what is not only emotionally difficult but it can lead to equally complex tax issues. For the most part, for tax purposes, any property acquired in a divorce is a gift and is non-taxable for income tax purposes. The cost basis of that property — its value for figuring any taxable gains at the time when you sell it — is the same as your ex-spouse's. If the property is an income-producing asset — e.g. rental property or a stock portfolio — any taxable gains or losses from that asset are divided at the date of transfer.
While a divorce can be emotionally devastating, it can be equally complicated for your financial stability. In addition to having an excellent lawyer, make sure you have an experienced accountant to guide you through the process. As with most things in life, if you do your homework and plan ahead, you can survive a divorce with your sanity and your bank accounts intact.
What are your experiences with divorce and how it changed your financial planning? Please leave your comments below.