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Watch Out for Tax Consequences in Divorce

When you are in the process of getting a divorce, the last thing you want to worry about is your tax return. However, there are often significant tax consequences for both spouses once the divorce process is completed. It is important for you to be aware of what the possible outcomes could be, so you are not saddled with an expensive surprise after the divorce is final.

Child Support and Alimony

By far the biggest question for most couples is how to handle child and alimony in tax terms. Child support and spousal support are addressed differently in the eyes of the IRS. Child support is never deductible for the parent who is making the payments and it is never considered income for the parent who is receiving the payments.

Alimony is treated differently by the IRS, however, whether or not it can or must be claimed on tax returns depends on when the couple’s divorce became final. For divorces that were final on or before December 31, 2018, alimony must be reported as taxable income by the spouse who is receiving the payments. The spouse who is making the payments can deduct the payments on their return.

If the couple’s divorce was finalized after December 31, 2018, the reporting requirements and deduction benefits were permanently eliminated under the Tax Cuts and Jobs Act. Alimony is basically being addressed the same way as child support as far as the IRS is concerned.

Child Deduction

Even if you cannot deduct child support, you may be able to claim your children as dependents. The IRS offers several child-related tax credits but is clear that only one parent may claim them in a given tax year. There are different ways divorced parents can address this. One familiar solution is that parents alternate years taking the deduction. No matter what solution you come up with, make sure it is specified in your final divorce agreement.

Property and Asset Transfers

The other major questions that come up regarding tax consequences after divorce have to do with property division and assets. It is important to differentiate between value and basis and understand that even if you receive more property, it may be a net loss due to capital gains tax.

In legal terms, basis is defined as the value assigned to an asset for purposes of sale or transfer. It takes into account the price in currency, but also any possible deductions you might take. For example, if you purchase an automobile for $40,000, and are able to claim $5,500 in deductions for the car, the adjusted basis of the car is $34,500. If you later sell the car for $44,500, the net gain is $10,000, even though you paid $40,000 for the car. This is important because capital gains taxes are calculated on basis, not initial value when it comes to most assets.

When an asset that has been held for more than a year is sold at a profit, it is taxed under the capital gains tax law. You must pay capital gains tax on any profit you obtain that is over the amount of any exemptions you can claim. For example, if you are single, you will pay no capital gains tax on the first $250,000 of profit when you sell your home. If you received the marital home in your divorce, and it is worth $400,000, but you sell it for $600,000, you will pay capital gains tax on $350,000 (the sale price minus your exemption amount). There are both federal and state capital gains taxes you would be responsible for. At the current rate, that total tax bill would be equal approximately $41,000.

Contact a Rhode Island Property Division Attorney

Divorce is intimidating enough without the specter of owing the IRS more money than you have. This is why it is critical to have a skilled Rhode Island divorce attorney negotiating your final divorce settlement for you. To learn more, call Kirshenbaum Law Associates at 401-467-5300 for a confidential consultation.