Divorce and Taxes
Divorce and Taxes: What You Must Know
- Filing status and withholding must reflect your marital status as of year-end. Update your W-4 and tax return accordingly.
- Tax treatment of alimony and child support. For new divorces, Alimony and child support are not tax deductible to the payor and not taxable to the payee.
- Only one parent can claim a child as a dependent per year. Know the IRS rules and ensure this is clearly addressed in your decree.
- Property and retirement transfers can trigger taxes if mishandled. Use QDROs and follow IRS guidelines for tax-free treatment.
- Tax planning during divorce is essential. Poor planning can lead to penalties, overpayments, or IRS audits.
- Beware of Tax Traps in Property Division: Basis and Capital Gains Matter. Don’t compare “apples to oranges” of the different tax consequences of dividing property.
Divorce and Taxes: What You Need to Know in Advance
Taxes often take a back seat in divorce preparation and planning at both the filing and settlement or trial stages in divorce, but they really, really shouldn’t. Every major financial decision in a divorce has potential tax consequences. If overlooked, those consequences can defeat the fair financial resolution of the case.
From alimony to child support, from retirement accounts, property settlements, to dependent claims, here’s a basic introduction to what you need to understand to avoid costly mistakes.
1. Marital Status Affects Filing Status and Withholding
Your marital status on December 31 determines your tax filing status for the entire year. If your divorce is finalized by that date, you can no longer file jointly—you’ll file as either Single or Head of Household, if eligible.
To qualify for Head of Household, you must have a qualifying dependent and have paid more than half the cost of maintaining your home. This status comes with better tax brackets and deductions, but only one parent can claim it for each child per year.
If your divorce isn’t final by year-end, you may still file a joint return—but this comes with the risk of joint liability for tax debts, even if they relate to your spouse’s income or deductions.
For more on this, see the IRS’s official guidance: Some Tax Considerations for People Who Are Separating or Divorcing.
2. Alimony vs. Child Support: Tax Treatment for Both Payor and Payee
Alimony
The tax treatment of alimony depends on when your divorce was finalized.
- Divorces finalized on or before December 31, 2018:
- Payor: Alimony is tax-deductible.
- Payee: Alimony is taxable income.
- Divorces finalized on or after January 1, 2019 (under the Tax Cuts and Jobs Act):
- Payor: Alimony is not deductible.
- Payee: Alimony is not taxable.
This change significantly affects negotiations. For pre-2019 divorces, alimony could be structured to reduce the overall tax burden by shifting income from a high-bracket payor to a lower-bracket payee. That incentive is gone for newer divorces.
If you modify a pre-2019 order after 2018, you must specifically opt in to the new tax rules; otherwise, the original tax treatment continues.
Child Support
Unlike alimony, child support has never been tax-deductible or taxable, regardless of when the divorce occurred.
- Payor: Cannot deduct child support payments.
- Payee: Does not report child support as income.
Because child support is treated as a personal obligation to the child, not the other parent, the IRS excludes it from income and deduction rules entirely.
In settlement negotiations, it’s crucial not to confuse alimony with child support—or structure payments in a way that could be reclassified by the IRS.
3. Claiming Children on Taxes: Only One Parent Can Do It Each Year
When parents file separately, only one may claim a child as a dependent per year. This affects:
- Child Tax Credit
- Earned Income Credit
- Head of Household status
By default, the parent with whom the child lives more than 50% of the year gets to claim the child. However, parents can agree otherwise—usually by the custodial parent signing IRS Form 8332 to transfer the exemption.
Disputes often arise when this isn’t addressed clearly in the divorce decree, resulting in duplicate claims, audits, and delays in refunds.
4. Retirement and Property Transfers: Tax-Free Only If Handled Properly
Transfers of property “incident to divorce” are not taxable—but there are strict rules.
For example, retirement assets in 401(k)s or pensions must be divided by a Qualified Domestic Relations Order (QDRO) to avoid early withdrawal penalties and taxes. IRAs can be divided tax-free if done by direct transfer pursuant to a decree.
If assets are liquidated or transferred incorrectly, the IRS may treat the transaction as a distribution, triggering income tax and a 10% penalty for early withdrawals.
Consult both your attorney and a tax advisor when dividing any significant financial asset in divorce.
5. Beware of Tax Traps in Property Division: Basis and Capital Gains Matter
Although property transfers between spouses or incident to divorce are generally non-taxable at the time of transfer under federal law, that doesn’t mean they’re tax-neutral in the long run. When one spouse receives an asset—whether it’s the marital home, a rental property, stocks, or personal property—they also receive that asset’s cost basis. This basis determines what capital gains tax will be owed when the asset is eventually sold.
For example, if you receive the marital home and later sell it, you may owe capital gains tax on the increase in value since it was purchased—not since it was awarded to you in the divorce. This can result in a much higher tax bill than you might expect, especially if your ex-spouse received liquid assets or retirement accounts that don’t carry the same future tax exposure.
Selling the marital home? If you meet IRS qualifications, you may be able to exclude up to $250,000 (or $500,000 if still filing jointly) in capital gains—but only if you lived in the home for two of the last five years.
It is essential not to compare “apples to oranges” in dividing property. A dollar in a checking account is not equivalent to a dollar in appreciated real estate, artwork, or a business interest with future tax liabilities. Always evaluate the after-tax value of assets and, where necessary, work with a CPA or forensic accountant to ensure a truly equitable division.
6. Post-Divorce Tax Adjustments: Don’t Forget the Paperwork
After divorce:
- Reevaluate estimated tax payments if you are self-employed or receive alimony.
- Submit a new Form W-4 to your employer to reflect your changed status and withholding needs.
- Understand that legal fees are not tax-deductible in most cases—unless incurred to generate taxable income (such as enforcing a pre-2019 alimony order).
Avoid Tax Trauma by Planning Ahead
Divorce may legally end a marriage, but it doesn’t end the need for careful financial planning. The IRS will not give you a break for mistakes made during divorce.
Tax consequences affect both short-term cash flow and long-term financial security. Whether you’re paying or receiving alimony, claiming a child, or dividing a 401(k), what you don’t know can cost you.
For more information, visit IRS Tax Considerations for Divorcing Couples.
Dividing assets and structuring support obligations during divorce involves more than just splitting everything down the middle—it requires a clear understanding of how taxes will affect each party now and in the future.
To avoid costly mistakes and ensure a truly fair outcome, it’s essential to work with a skilled divorce attorney who understands both the legal and financial landscape, and to consult with a qualified CPA or tax advisor who can help evaluate the tax implications of your settlement to minimize tax exposure—for both sides. Smart planning today can prevent expensive surprises tomorrow.
