When advising clients who have recently separated, divorced, or become legally separated, it’s important to look beyond filing status alone. A change in marital status can affect many aspects of a taxpayer’s return, and overlooking key issues may lead to missed tax benefits, reporting errors, or compliance issues.
Tax preparers should consider several important tax topics after separation or divorce, including filing status, claiming dependents, withholding updates, property settlements, child support, alimony, legal fees, and community property rules. Each of these can have a significant impact on filing obligations and tax liability.
Filing taxes as a legally separated couple
If your client has a legal separation decree or maintenance agreement, the IRS generally no longer considers them married for tax filing purposes. If the divorce or legal separation was finalized before December 31st of the tax year, each spouse must file an individual tax return. In most cases, they will file as Single, unless they meet the qualifications for Head of Household, or have remarried before the end of the year.
If the divorce decree or separation maintenance was not finalized by December 31 of the tax year, the couple is still considered married for tax purposes and must file as either Married Filing Jointly or Married Filing Separately.
Tax preparers should confirm which parent will claim any dependents after the separation or divorce. This decision can affect eligibility for certain tax benefits and filing statuses. To qualify for Head of Household status, a taxpayer generally must:
- Pay more than half the cost of maintaining a home for the year.
- Have a qualifying dependent living with them for more than half the year.
Only the custodial parent can qualify for Head of Household status based on a child, even if the noncustodial parent is allowed to claim the child as a dependent for certain tax benefits under a divorce decree or by using Form 8332. The right to claim a dependent for specific tax benefits does not transfer eligibility for Head of Household filing status.
Claiming dependents after separation or divorce
Determining which parent may claim a child as a dependent is one of the most common tax issues that arises after a separation or divorce. Tax preparers should understand the distinction between custodial and noncustodial parents, as well as the tax benefits that may be affected by dependent claims.
For tax purposes:
- Custodial parent is generally the parent the child lived with for the greater number of nights during the year. Generally, the custodial parent will have the right to claim the child as a dependent.
- Noncustodial parent is the parent who the child lived with for fewer nights. They may still claim the child as dependent if the custodial parent agrees and signs Form 8332, releasing their claim to the dependent.
In some cases, divorced couples choose to alternate years claiming a child as a dependent. If there are multiple children, they may also agree to divide dependent claims, with each parent claiming one or more children. Regardless of these arrangements, tax preparers should verify that the taxpayer meets IRS requirements and has the appropriate documentation.
Keep in mind that claiming a dependent can affect eligibility for valuable tax benefits. The parent who claims the child may qualify for benefits such as the Child Tax Credit, while the custodial parent may remain eligible for certain benefits tied to the child’s residency, like Head of Household filing status, and the Child and Dependent Care Credit.
Tax treatment of child support payments
Child support payments are not deductible for the parent who pays them and are not considered taxable to the parent who receives them. Typically, child support is only relevant during tax filing if a parent is delinquent on child support payments. In this case, all or part of their federal tax refund may be seized by the IRS and applied toward part-due child support through the Treasury Offset Program. .
As the tax preparer, you are not responsible for determining whether aclient is behind on child support payments and do not need to take any special action when filing their return. However, it can be helpful to inform clients that an expected refund may be reduced or withheld if they have outstanding child support debt.
Tax treatment of alimony payments
Clients who pay or receive alimony may ask whether alimony is deductible or taxable. The answer depends on when their divorce and alimony agreement was finalized and whether a later modification changes the tax treatment of payments.
For divorce or separation agreements finalized on or before December 31, 2018, alimony payments are generally deductible by the payer and taxable income to the recipient.
For agreements finalized after December 31, 2018, alimony payments are not deductible by the payer and are not taxable income to the recipient. These changes were introduced by the Tax Cuts and Jobs Act. Tax preparers should also be aware of modified agreements. If a pre-2019 agreement was modified after December 31, 2018, the original tax treatment generally continues to apply unless the modification specifically states that the new tax treatment under the Tax Cuts and Jobs Act applies.
Taxpayers generally fall into one of three categories: :
- Agreements finalized on or before December 31, 2018: Alimony is deductible for the payer
- Agreements finalized after December 31, 2018: Alimony is not deductible for the payer and is not taxable to the recipient.
- Pre-2019 agreements modified after December 31, 2018: The original rules generally remain in effect unless the modification expressly adopts the post-2018 tax treatment.
When preparing a return, be sure to review the date of the divorce or separation agreement and any subsequent modifications to determine the correct tax treatment of alimony payments.
When to update tax withholdings after a divorce or separation
Once a divorce or legal separation is finalized, both parties should review and adjust their withholdings. This typically means submitting a new Form W-4 to their employer. If the change in filing status means they are currently withholding less than their new estimated tax liability, then they must provide a new W-4 within 10 days of the change. This is especially important for clients moving from Married Filing Jointly to Head of Household or Single.
If your client is waiting for a divorce or separation to be finalized, consider adjusting their W-4 in advance to reflect the expected difference in filing status, income, or the number of dependents they will claim. This proactive step helps avoid under or over-withholding once their filing status changes.
Losing certain credits and deductions, such as the Child Tax Credit, Earned Income Tax Credit, or the higher standard deduction for joint filers, can significantly increase tax liability. As a tax preparer, you should forecast how these changes will affect your client’s overall tax situation and recommend higher withholding if needed to prevent surprises at tax time.
Note: If one or both of your clients are self-employed, they may need your help recalculating and updating their estimated tax payments after the divorce.
Tax implications of property settlements
Reaching a property settlement in a divorce can be challenging, but the tax rules are generally straightforward. In most cases, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of divorce.
The gift tax generally does not apply to property transfers that are a part of a divorce. However, the gift tax may apply if one spouse voluntarily gives property or money outside the divorce agreement, or if either spouse is a nonresident alien.
Qualified retirement accounts, such as 401(k)s and pensions, usually require a Qualified Domestic Relations Order (QDRO) to transfer assets between spouses without triggering taxes or early withdrawal penalties. Without a QDRO, distributions may be treated as taxable income and could incur a 10% penalty. Make sure clients understand this requirement and complete the QDRO process promptly.
If the transfer occurred under a divorce decree or under a written agreement related to the divorce (i.e. that occurring within the three-year period of one year before the divorce and two years after), the gift tax will not apply.
Are legal fees in a divorce tax deductible?
Legal fees related to divorce are not tax deductible in most cases. However, there are some exceptions. Legal fees from a property settlement related to divorce can’t be deducted from taxable income, they can be added to the basis of the property, reducing any potential tax your client may owe on the property.
If a spouse pays for the legal fees of their ex-spouse and is not under any legal requirement to do so, the payments are considered a gift and are subject to the gift tax if they exceed the annual exclusion amount. Unless a special arrangement has been made, the donor is responsible for paying the gift tax.
Filing in community property states
Under community property law, most types of assets, income, and property belong equally to both parties. This means income generated before the “marriage community” was officially dissolved must be split evenly between the two parties’ tax returns.
If your clients live in one of the nine community property states listed below, they may need to report community income on separate tax returns:
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
A finalized divorce ends the marriage community, and in some, being legally separated or simply living separately can also terminate it. As the tax preparers, you should confirm state-specific rules regarding when the community ends.
The IRS provides exceptions for couples who lived apart for the entire year and meet certain conditions. Under these provisions, they may avoid treating income as community income. Review IRS Publication 555 and Publication 504 for details on eligibility and documentation requirements.
In community property states, the IRS may require Form 8958, Allocation of Tax Amounts Between Certain Individuals in Community Property States, to properly report income, deductions, and credits between spouses or former spouses.
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