Divorce is more than just an emotional and legal process, it’s also a financial and tax event. If you’re going through a divorce in New York, it’s critical to understand how the separation will affect your taxes, both in the short term and long term. Failing to account for tax liabilities during the divorce process can lead to unexpected costs, penalties, or legal complications down the road.
When Do You File Single?
Your filing status is determined by your marital status on December 31 of the tax year. If your divorce is final by then, you'll file as Single or, if qualified, Head of Household. Claiming as head of household generallyprovides you with higher tax brackets and more standard deduction but comes with some IRS stipulations, typically being the custodial parent and contributing more than half of the cost of maintaining your residence.
If your divorce won't be finalized until the end of the tax year, you canstill file jointly or file separately, but both of your spouses areresponsible for the return and any accompanying tax debt. This is especially convenient when one spouse has not reported income or hasclaimed deductions that could result in an audit. In some situations, innocent spouse relief can be utilized when you are unfairly held accountable for a spouse's tax mistakes.
Child Support and Taxes
Child support payments in New York are not deductible by the parent paying the child support. Additionally, the parent receiving child support does not claim child support as taxable income. This provision of the IRS is one that is blanket and cannot be waived, regardless of what your divorce settlement dictates.
But tax credits for kids are a different matter. Usually, the custodial parent gets to claim the child as a dependent and can claim the Child Tax Credit, the Earned Income Tax Credit, and the child care expense deduction. Some parents choose to switch taking these credits every other year or negotiate with their higher-income spouse taking them in order to receive the greatest tax benefit, but this must be specified in the divorce decree.
Spousal Maintenance (Alimony) and Taxation
Spousal support, or alimony, has significantly changed since the Tax Cuts and Jobs Act (TCJA). For divorces finalized after December 31, 2018, alimony is no longer deductible by the payor spouse and is not includible in the income of the payee spouse. This applies to both federal and New York State returns. If your divorce was finalized before 2019, older tax rules may still apply.
It is essential to have your Qualified Domestic Relations Order (QDRO) or your other alimony arrangements inspected by a veteran family law attorney and tax expert to ensure that you are aware of how the maintenance payment impacts your taxable income.
Dividing Marital Property
New York is an equitable distribution state when it comes to community property, meaning property is divided equally, not always but often, when they divorce. Gifts between spouses of property when they're in the process of divorce are usually not taxable, as long as they're within specified IRS time limits: one year from the divorce or six years if outlined in the divorce settlement.
Later on, though, if you sell the property, you might be required to pay capital gains tax. For example, if you receive the house in your divorce from your marriage and subsequently sell it, you can only exempt up to $250,000 of the profit from your tax income if you're a single taxpayer. If you and your ex-spouse sell the house jointly prior to the finalization of the divorce, you may qualify for the $500,000 capital gains exclusion. Having knowledge about how property transfers affect tax liabilities in the future is a significant part of negotiating divorce.
Retirement Plans and QDROs
Withdrawal of retirement plans like 401(k)s, or pensions requires a Qualified Domestic Relations Order (QDRO). Without a QDRO, retirement plan withdrawals can draw tax and penalties upon withdrawal. Correctly executed, a QDRO allows you to transfer money from the retirement account to your ex-spouse without tax at time of transfer. The recipient pays regular income taxes at retirement withdrawal, however.
For IRAs, divorce transfers are tax-free if handled correctly as a transfer incident to divorce, but you will still need to maintain your documents in IRS-compliant form.
Tax Debts, Refunds, and Divorce
Tax debt complicates a divorce, especially if a joint return existed in the past. The court must decide whether debts owing are marital or separate debts. Tax debts incurred during the marriage are generally marital and split equally between spouses, but exceptions apply when fraud or underreporting is an issue.
Some couples also agree on the distribution of tax refunds or future tax liability responsibilities as part of the agreement. This can prevent strife in case of an IRS audit or a refund issue later on after the divorce.
Legal Fees and Tax Deductions
Most divorce-related legal expenses are not deductible. There are some exceptions, though. For instance, fees paid for tax advice related to your divorce or for the purpose of claiming spousal support may still be deductible as miscellaneous itemized deductions, but they come with some limitations.
Having both a family law attorney and a tax professional consult with you is the greatest safeguard for your financial future. With their assistance, you can create a divorce strategy that minimizes taxes while complying with New York State and federal tax laws.