Divorce impacts many areas of life, and taxes are no exception. With proper planning and awareness, you can avoid costly surprises and ensure a smoother financial transition. Below are the major tax considerations for those navigating a divorce during the 2024-2025 tax years.
1. Filing Status: Timing Is Everything
Your filing status for the tax year depends on your marital status on December 31. If your divorce is finalized before year-end, you must file as single or, if eligible, head of household. However, if you are still legally married as of December 31, you can file either jointly or separately. Filing jointly often results in a lower tax liability, but both parties must agree to it.
If you are getting or got divorced in 2024, it is crucial to adjust your withholding during the year if your filing status changes. For instance, if you were withholding taxes at a married rate but finalize your divorce before year-end, your withholdings may be insufficient, potentially leading to underpayment penalties.
2. Dependency Exemptions: Who Claims the Kids?
Claiming dependent children can significantly affect your tax return. The custodial parent—the parent with whom the child resides the majority of the year (183 overnights or more)—typically claims the dependency exemption. However, the custodial parent can transfer this right to the non-custodial parent using IRS Form 8332, which must be filed with the non-custodial parent’s tax return. To avoid disputes, clearly address who will claim the children in the divorce decree. This arrangement also affects related tax benefits, including the Child Tax Credit and the Child and Dependent Care Credit.
For people going through a divorce, this issue can be complex because they may still be living in the same home for most of the tax year.
3. Property Division and Tax Implications
Property division in divorce can be complex, particularly regarding taxes. Transfers of property between spouses as part of a divorce are generally tax-free. However, the recipient assumes the original cost basis of the asset, which can have tax consequences upon future sale (or if sold during the case). For example, if one spouse retains the family home, they may face significant capital gains taxes when selling it later. Carefully structuring the division of assets with these factors in mind can prevent unexpected tax burdens down the line.
It could be advantageous to sell an asset now rather than later. The opposite could be true. You and your attorney/accounting team need to strategize on how to optimize things for your situation.
4. Maintenance and Child Support
Tax treatment of alimony/maintenance and child support depends on when your divorce agreement was executed. For agreements finalized before 2019, alimony payments are deductible for the payer and taxable for the recipient. However, for agreements made after December 31, 2018, under the Tax Cuts and Jobs Act, maintenance payments are neither deductible nor taxable. On the other hand, child support payments are not deductible for the payer nor taxable for the recipient, regardless of the timing of the agreement. Understanding these distinctions is essential when negotiating financial arrangements in your divorce.
5. Harvesting Gains or Losses
If you and your spouse share investment assets, the timing of asset sales can significantly impact your tax obligations. Selling assets before year-end may allow you to harvest gains or losses that align with your tax brackets or offset taxable income. Keep in mind that any asset transfers incident to divorce are typically tax-free, but the recipient assumes the original cost basis of the asset. Planning around these factors ensures that capital gains taxes are minimized and divided fairly in accordance with the divorce agreement.
6. Self-Employment and Business Ownership
If you or your spouse owns a business, the divorce process may trigger significant tax implications. Business valuations, income adjustments, and potential tax liabilities related to capital gains or depreciation recapture must be considered. If the business is jointly owned, decisions about its division or continuation need careful tax planning. Consulting with a forensic accountant or financial expert ensures the business’s value is accurately assessed and tax consequences are minimized.
7. Tax Estimates: Avoiding Surprises
Changes in your financial situation during divorce can alter your tax liabilities. Review your estimated taxes to ensure compliance and avoid penalties for underpayment. Overpayments or refunds tied to joint accounts should also be addressed in the divorce settlement, as these funds are often subject to division. Properly adjusting your tax estimates ensures that both parties meet their tax obligations without unexpected financial burdens.
Usually, an overpayment in taxes is an asset and an underpayment in taxes is a liability to the marital estate.
8. Yearly Gifts and Estate Planning
Divorce can also influence your gifting and estate planning strategies. Each individual can give up to $18,000 per recipient annually without triggering gift taxes. During divorce, gifting strategies can help support children or other family members while staying under the annual exclusion limit. Planning for these gifts as part of the overall divorce settlement can provide tax advantages for both parties while ensuring financial support for loved ones.
9. Potential Tax Policy Changes
With changes in political leadership, tax laws may evolve, potentially impacting your divorce agreement. Tax policies, including adjustments to standard deductions, tax brackets, or maintenance taxation, could affect financial planning. Stay informed about federal tax changes, as they may alter the benefits or obligations tied to your divorce settlement. Consulting with a tax professional can help you anticipate and adapt to these changes.
10. Professional Guidance: Navigating the Complexity
Taxes concerning divorce involve many moving parts, and professional guidance is invaluable. A family law attorney can help structure your divorce agreement to account for tax implications, while a tax professional can assist with year-end planning and compliance. Together, they ensure that you minimize tax burdens while aligning your financial strategy with the terms of your divorce.
Final Thoughts
Understanding the tax implications of divorce can save you significant financial stress and uncertainty. Filing status, dependency exemptions, property division, and alimony taxation all play critical roles in shaping your financial future. Planning ahead and seeking professional advice will help you navigate these challenges effectively. If you’re going through a divorce, contact our team today to guide you through the legal and financial intricacies, ensuring a smoother transition into your next chapter.
Christopher Griffiths is a Shareholder and Chief Financial Officer at Griffiths Law—a law firm specializing in family law and civil litigation.