Divorce can be challenging, and taxes might be the last thing on your mind. However, certain tax issues are important to address and will help keep your tax burden minimal. Here are the six main tax considerations to be aware of during your divorce process:

1. Sale of Home

Generally, when a couple sell their home during a divorce or legal separation, they can avoid paying taxes on up to $500,000 of gain. This is assuming they have owned and used the home as their principal residence for at least two of the previous five years. If the couple does not meet the two-year ownership requirement, the gain may still qualify for a reduction due to sale from unforeseen circumstances. Reach out to Wegner CPAs for help with calculating the gain from the sale of your home.

If only one spouse continues living in the home, but they both continue owning the home, they can each still avoid paying taxes on up to $250,000 of gain. Special language may need to be included in the divorce decree or separation agreement to protect this tax benefit for the spouse who moved out.

2. Impact on Pension Benefits

Typically, a spouse’s pension benefits are included as property in a divorce settlement. To help manage these benefits, the common method is to get a “qualified domestic relations order” (QDRO). A QDRO allows for both spouses to receive pension benefits while sharing in the tax consequences. Without a QDRO, the spouse who earned the benefits will pay the tax on the income, even though the other spouse receives the funds.

3. Changing of Your Filing Status

For tax purposes, if the divorce is not finalized by the end of the year, you are still considered married. If you are considered married at year end, you may file as married filing jointly, married filing separately, or head of household (certain requirements must be met for this status). Wegner CPAs can assist in determining the best filing status for your tax return.

4. Payments for Alimony or Support

For divorce or separation agreements signed after 2018, alimony and support payments are no longer tax deductible by the paying spouse. These payments are also not counted as income for the receiving spouse. This was a permanent change signed under the Tax Cuts and Jobs Act and differs from rules for divorce/separation agreements signed before 2019.

5. Claiming Dependents and Child Support

You and your ex-spouse will need to determine who will claim your child or children on your tax returns to take advantage of any dependent related tax breaks. Child support payments are not deductible by the paying spouse nor taxable to the receiving spouse.

6. Business Interests

If business interests are transferring because of a divorce, it is important to assure tax benefits are not lost. For example, if you have ownership in an S corporation, you may have “suspended” losses – losses that can only be deducted in future years. If your ownership in the corporation transfers, you might lose the benefit of those suspended losses. The transferring of partnership interest can result in complex issues involving partnership debt allocations, capital accounts, gains on contributed property, and more.

The Various Tax Challenges

The six-considerations listed above are just a few of the tax complications with getting a divorce. Additionally, certain states, such as Wisconsin, are known as Community Property states. This generally means you must split income, tax deductions, and tax withholdings in the year of divorce up until the date the divorce becomes final.  This unique tax return reporting requirement is a commonly missed detail which results in filing amended returns and incurring additional tax preparation fees to properly allocate income/deductions/withholdings between spouses and between “married tax period and “divorce tax period’”.  You may need to adjust your income tax withholding, and you should notify the IRS of any new address or name changes.  Last, you also may also need to update estate planning consideration.

We’re here to help you navigate the complex financial landscape of divorce. Please reach out to a Wegner CPAs tax advisor for assistance with these financial matters.