There are so many changes that come with divorce, and one that you might not think about right away is that divorce can significantly change your taxes. Whenever there’s change, there is a chance to make mistakes. So let’s take a look at three common divorce tax mistakes people make during and after their divorce and what you can do to avoid these pitfalls.
Mistake #1: Choosing the Wrong Filing Status
Your marital status as of December 31 of the tax filing year will determine your filing status for that year. If your divorce is finalized by that date, you will file solo — even if you were married for a good chunk of the year. If your divorce is not yet finalized, you have the options of filing “married filing jointly” or “married filing separately.”
Filing jointly means that you will preserve the same tax benefits as in previous years. Even when couples are on good terms and do want to file jointly, putting in place an agreement for how the refund or liability will be handled cuts down on a lot of confusion. It makes the process more transparent.
Other times, filing separately is preferred — especially if you are getting financial red flags from your spouse. If there have been tax issues in the past, filing separately is a way to help establish immunity from any tax mistakes or misstated assets and income. In these situations, it would most likely be a mistake to go along with a joint filing.
Mistake #2: Thinking child exemptions no longer matter.
Under the Tax Cuts and Jobs Acts of 2017, personal and child/dependent tax exemptions were set at $0 for the tax filing years 2018-2025. This can be really confusing if you are new to filing your taxes on your own or you haven’t been paying much attention to all the new tax changes from that Act.
If it’s zero, does it still matter on your taxes?
The answer to this is an emphatic yes! If you have children, taking the exemption is still important because it will give you the ability to qualify for the child tax credit and/or earned income credit if applicable.
But the other trick to this is that only ONE of you can claim your child as a dependent after divorce and get the credit. Generally, the parent with primary custody is entitled to claim the child, but this can be subject to negotiation, especially in 50-50 situations.
Parents may agree to alternating years for claiming the child tax credit or other mutually agreed upon schedule.
Mistake #3: Not realizing that alimony tax rules have changed.
The other major change that came out of the Tax Cuts and Jobs Act is a new tax rule apply that applies to alimony orders put in place on or after January 1, 2019.
Previously, the spouse required to pay alimony could deduct payment amounts from their income taxes. The spouse who received alimony had to claim it as income. Now this is still true for anyone who had an alimony order before 2019 — these have been grandfathered in.
Under new tax rules applied to new orders, alimony payors can no longer claim the deduction; alimony payments remain part of taxable income. Spouses who receive alimony are not required to claim alimony as income.
It’s a big change. Under the old rules, being able to deduct alimony payments was so advantageous for paying spouses that it was often possible to negotiate higher payments for the recipient spouses — the tax cut was just that good!
Now that those days are over, new ways may be needed to negotiate alimony with taxes in mind. Some of these methods might include a lump sum payment that gets the “tax hit” over in one year. Or looking at negotiating with various assets, that of course, can come with tax liabilities of their own.
For spouses who receive alimony, any “alternative plan” must of course be subject to great scrutiny to ensure their financial big picture will be safeguarded.
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