During a divorce, there are a number of issues that need to be agreed upon by the two spouses. One of the biggest issues that will need to be resolved is the financial component of a divorce agreement.
People often know that there will be some financial implications when going through a divorce. What they may not know is that a divorce can also affect their taxes.
Both taxes and divorce are complicated topics. As with all complex subjects, a lot of questions often arise when determining how a divorce agreement impacts someone’s taxes. These are three of the most common tax issues that could arise during or after a divorce is finalized.
If a spouse is ordered to pay alimony, those payments may be tax deductible. In order for the alimony to be eligible for a tax deduction, it must meet the following seven criteria established by the IRS:
- The spouse paying alimony is not filing a joint return with their ex-spouse
- Alimony was paid in cash
- The payment was made as a result of a divorce or separation
- The payment is not viewed to be child support or a property settlement
- After the recipient spouse dies, there is no longer a legal liability to continue making payments
- At the time the payment is made, the two spouses cannot belong to the same household
- The payment cannot be designated as something other than alimony
For spouses that are receiving alimony, the income needs to be reported to the IRS in the year that it was received. Additionally, because taxes aren’t withheld on alimony, it may be necessary to make estimated tax payments during the year in order to avoid a potential penalty.
Alimony and child support often get lumped together. From a tax perspective, alimony and child support are not the same thing. While alimony payments may be tax deductible, child support cannot be deducted. Similarly, the spouse that receives the child support does not have to report those payments as income.
Contributions to retirement accounts
If a contribution was made to an ex-spouse’s tax-deferred IRA, those contributions are no longer tax deductible. For example, imagine a tax-deferred contribution was made in February. If the couple divorced in September, those contributions cannot be deducted. Any contributions made to your own tax-deferred IRA may still be tax deductible.
The intersection of divorce and tax planning is an area where tax specialists and lawyers can provide additional value. Understanding the tax laws surrounding divorce can help you avoid negative consequences the next time you file.