By Eric Harvey, J.D. | Legally reviewed by Melissa Bender, Esq. | Last reviewed July 14, 2023
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Divorce has become an everyday reality in the United States. If you plan to get a divorce, you should pay close attention to your short- and long-term tax exposure before dividing marital assets.
For instance, divorcing spouses who are still legally married can save money if they file their taxes jointly. Read on to learn about the effects of divorce on taxes and your estate plan.
After a divorce, you need to remember:
Generally, your taxable income, tax deductions, and tax brackets are given tax breaks while married. A divorce will take away many of the benefits of filing jointly.
Once you file separate returns, there will be different standard deductions and tax refunds. You can speak with a tax advisor to see how your marital status will change your tax situation.
Until the divorce is final, you are legally married. You should continue to file a joint return unless you have a final divorce decree before the tax year's last day.
If you get a decree of annulment, you need to file an amended tax return for every tax year affected by the annulment.
You also can legally separate or live separately from your spouse during a divorce. In these cases, you may be able to file as "head of household." Your divorce attorney should be able to answer your filing status tax questions while the divorce is in progress.
For married couples, filing separate tax returns is incredibly costly. If you and your spouse can agree to continue to file jointly until the divorce is final, you'll save yourself a lot of money.
But be cautious because you'll be jointly liable if your spouse incurs tax liabilities and penalties.
The back taxes you owe will be split up, and each person pays according to their taxable income, assets, and tax deductions. If your ex-spouse makes more money than you, they will likely need to pay more.
For example, if you make $40,000 and your ex makes $80,000, you would not split the back taxes 50/50. You would pay less because of your income (unless you have other significant assets).
Splitting the back taxes is helpful if you have tax debt after divorce. It allows each party to pay a percentage and does not throw your ex's taxes all on your shoulders. To split your back taxes, you must fill out IRS Form 8857.
Unless a court decree stipulates otherwise, the custodial parent is entitled to the dependency exemption (which can be released through IRS Form 8332). Only the custodial parent may take the child care credit, but both parents may be able to deduct medical expenses, regardless of custody.
If you are the custodial parent, you can claim the children if:
If you and your ex have a 50/50 custody split, then the custodial parent has the higher income.
If an ex-spouse claims the child on their taxes illegally, you should speak with a tax professional about the next steps. It is illegal for your ex to claim them if you are the custodial parent.
The IRS generally doesn't consider the transfer of assets between divorcing spouses a taxable event. If you show that divorce was the reason, you can transfer cash and assets between you and your divorcing spouse tax-free.
But if you and your spouse have accumulated assets such as mutual funds, stocks, bonds, or artwork, you can be subject to a large capital gains tax bill when you attempt to divide them.
For example, when you buy stock shares from your spouse, the cost of that stock (for you) has risen. But you'll still be taxed based on the capital gains earned between the time you and your spouse bought the stock at the original price and when you sell. Meanwhile, your ex-spouse doesn't need to pay taxes on the money you paid to buy the stock from him or her.
For most couples, their home is their most valuable jointly-owned asset. Typically, upon divorce, you have three options:
You can avoid paying capital gains taxes on the profits from your home sale if you reinvest the home sale proceeds within two years. The home must be your principal residence, meaning you have lived there for at least three out of the last five years.
Divorced spouses can have difficulty meeting this requirement when the settlement allows one spouse to remain in the home for more than two years before it's sold. The ex-spouse not living in the home can then lose their eligibility to avoid the capital gains tax, so it's something to consider when working out an agreement.
Retirement funds can be treated as marital property during a divorce settlement, so you may have to share retirement funds (including Social Security) with your spouse. If your spouse has a right to a part of your retirement funds, you must adhere to the applicable tax laws when you make distributions. You cannot "alienate" or "assign" your qualified pension plan distributions to anyone else.
If you have retirement funds that you must share with your spouse upon divorce, you should get a Qualified Domestic Relations Order (QDRO). A QDRO is a court order detailing the proper procedure for distributing your retirement benefits in the future.
It allows your benefits plan administrator to proceed with distributions as if you're still married to your ex-spouse. This ensures that both parties receive their rightful benefits.
The QDRO also resolves any issues if you or your ex-spouse remarries. Current and ex-spouses each receive a proportionate share of the plan distributions.
Upon divorce, IRAs are generally considered the sole property of the original owner. But if you contribute to your IRA from your earnings during your marriage, your spouse will be entitled to a proportionate amount of IRA assets. The exact distribution amount is subject to state laws.
IRA funds can be transferred tax-free from one spouse to another by a written divorce decree. But if you're the recipient of IRA funds, you can be responsible for a 20% federal income tax. Ask your IRA trustee to roll the funds into your own IRA to prevent this.
Taxes and property division aren't the only financial considerations during divorce. Depending on how far along you and your spouse are in your estate plan, you'll probably need to make a few updates to protect your finances. This includes updating any powers of attorney you have in place.
In your beneficiary designations and life insurance policy, for example, it's important to be sure that you properly designate who will receive payouts from the life insurance if you die. It's important to make sure you properly state who will receive payouts that are payable on death.
You'll also want to update your will. And even though you're getting divorced, you may still want to leave your ex-spouse with something. Some states revoke all gifts left to your spouse in your will automatically on divorce. If this is not what you want, you may need to be more proactive in your stated intentions.
In some states like Ohio, statutes provide for automatic revocation of any estate plan provisions that mention your former spouse. Be sure to check the applicable laws in your state and make any necessary changes. If you don't, you may unintentionally leave property and assets to your former spouse.
This process can be confusing. Laws dictating various aspects of divorce, estate planning, and taxes can vary quite a bit from one state to the next. It's always a good idea to speak to an attorney.
An attorney — an estate planning or a divorce lawyer — can help with the following situations:
Estate planning attorneys may also help with the following, as well:
At the same time, attorneys can also advise on the following:
It's important to note that this article does not constitute legal advice. If you're dealing with tax issues during your divorce, you'll want the help of an attorney experienced in divorce and tax law.
Once you find a local divorce attorney, ask them about their experience handling tax-related issues or estate planning matters.
The process of handling any divorce can be tricky, particularly when there are many assets at stake. After a divorce, be sure to protect your interests.
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