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The holidays are over, and the next season is upon us…tax season.

Separating your financial life because of divorce is challenging and often complex. It is especially difficult to deal with the financial aspects, including tax filing. Avoiding tax traps and other pitfalls means paying attention to details. To avoid unpleasant tax surprises when your marriage ends, understanding these five concepts can be valuable.    

  1. Tax implications of spousal support and child support

It is common for couples to get confused about the tax implications of support payments.

Let’s start with spousal support.  Alimony or spousal support/maintenance is a court-ordered payment either once the court orders it, or if the parties have agreed between them or through mediation and it then becomes a court order.  In 2018, Arizona added a couple of terms to enable spouses to qualify for spousal maintenance beyond the prior threshold terms. These two new terms include 1) if a spouse has made a significant financial or other contribution to the education, training, vocational skills, career or earning ability of the other spouse and 2) if a spouse has significantly reduced that spouse’s income or career opportunities for the benefit of the other spouse.  These changes, coupled with the tax cut and job act changes from 2017 – where the prior income deduction to the spousal maintenance payor was eliminated starting in 2019  – make it essential to consult with an attorney to ensure you know your rights!

Child support is typically paid by the parent who makes substantially more income than the other.  In Arizona, joint custody, called “equal parenting time”, is favored by the courts and is often ordered.  The child support calculator with equal parenting time greatly reduces the child support obligation between parents. Though tax deductions to not accompany child support, there are three benefits related to supporting a child:   1) the child tax credit, 2) head of household deduction and 3) child care credits.  These benefits need to be allocated between the parents and they can be alternated in different tax years.  In Arizona, the pro rata share percentage division between the parties’ incomes often is a guide to the percentage division of the current and future tax years in the child’s minority.

In 2022, a parent may be entitled to Advance Child Tax Credit payments –  early payments from the IRS that is 50 percent of the estimated amount of the Child Tax Credit that you may properly claim on your 2021 tax return during the 2022 tax filing season. If the IRS processed your 2020 tax return or 2019 tax return before the end of June, these monthly payments began in July and continued through December 2021, based on the information contained in that return.  Check with your accountant to ensure you are utilizing all credits available to you.

  1. Property division and taxes

The transfers of property during your divorce are generally not taxable events. However, there is a potential tax issue that is often overlooked: the tax basis. In some cases, divorcing couples may be able to structure a “true sale” of certain property more than one year after finalizing their divorce. By doing this, the spouse who purchases their ex-spouse’s share may take advantage of a higher cost basis on the property. A higher cost basis means less gain there is to be taxed—and therefore potentially, a lower tax bill.

Gains up to $250,000 in profit (filing as single) or up to $500,000 (filing as married), may be excluded from capital gains tax when it comes from the sale of residential property that has been used as your principal residence for two of the last five years.  Again, it is highly recommended to consult with both your attorney and your CPA on these issues in fairly dividing your assets and the tax liability associated with them.

  1. Choosing the right tax filing status

Your federal income tax filing status is determined by your marital status on December 31st of the tax year.

There are three filing statuses for taxpayers: single, married, and head of household. The different tax statuses and the choice of whether to file jointly or separately from your spouse can make a big difference in your tax liability. To find out exactly how much you would pay or save under each status, you will have to calculate your taxes under each status separately, and then consult with your tax advisor in regard to what factors could affect those amounts.

  1. Determining tax credits

Divorcing spouses need to understand the rules that the IRS uses to determine who can claim a dependent on a tax return. In many cases, the parent with whom the child resides for most of the year is eligible to claim the credit. However, there may be instances when it makes sense for the non-custodial parent to claim the credit. You may want to consider alternating who gets the tax credit each year or splitting multiple dependents between spouses.  This is a good negotiating point that can be offset with other points to negotiate in your divorce.  It is usually allocated by the percentage of the pro rata combined income over future years. So if Spouse A earns 70% of the combined gross income, and they pay child support, then they would ordinarily have the right to seek 70% of the remaining tax years of the child’s minority.

  1. Factoring tax carryovers

Carryovers, like capital losses, passive activity losses, net operating losses, and charitable deductions, are valuable, just like property.  When you negotiate how assets and liabilities will be divided, don’t forget to talk about any tax carryovers and of course, consult with both your accountant and your family lawyer.

Tax laws can be tricky, especially during a divorce. Before you finalize your divorce, discuss the details with your tax advisor so you can be sure of the tax implications. At McMurdie Law & Mediation our goal is to negotiate a divorce settlement that is designed to avoid costly financial consequences, including tax penalties. Contact McMurdie Law & Mediation today at 480-777-5500 for a no-cost initial consultation and case evaluation.