When people are going through a divorce and/or have just finalized a divorce, they often forget about tax consequences and considerations. That is a critical error on their part that could prove to be very costly. Divorce can take a financial toll, so it is financially prudent to take advantage of any tax benefits that may be available.
The following are a few common topics that should be addressed and considered to avoid adverse tax consequences. (It is also imperative that all of these matters must be discussed with a licensed CPA or other tax professional who has knowledge of the specific financial circumstances.)
1. Tax Filing Status
Couples who are separated but not yet legally divorced before the end of the year have the option of filing a joint tax return. For tax purposes, the marital status as of December 31st controls the filing status. Filing jointly may provide both parties with financial benefits. However, if a divorcing couple does elect to file jointly they (and their counsel) should enter into a written agreement about how any tax liability or refund will be allocated/distributed.
2. Medical Expenses
If either parent continues to pay a child's medical bills after the divorce, then the payor parent may include those costs in his or her medical expense deductions (even if the other parent has custody of the child and claims him or her as a dependent).
3. Spousal Support Payments/Alimony
The spouse who pays the alimony/spousal support can take a tax deduction for such payments provided that the payments are addressed in the divorce judgment. On the other hand, the spouse who receives the spousal support will have the support taxed as income. (Note: The same rules do not apply for child support payments, which are non-taxable and are not deductible.)
4. Asset Transfers
When an asset is transferred from one spouse to the other pursuant to divorce, it is a non-taxable event. It is imperative, though, that the transfer documents (ie deeds, QDROs, preliminary change in ownership forms, etc.) are prepared correctly to ensure that tax is not inadvertently and incorrectly applied. Furthermore, it is important to remember that the tax basis shifts as part of the transfer which could lead to capital gains tax in the event of future sale.