Anyone going through an emotional divorce is caught in a catch-22. Many of the decisions you make during your divorce will affect your future for years or decades to come. However, studies have shown that situations that generate negative strong emotions make it harder to take in information and make logical decisions. In other words, your strong feelings can make it harder to make informed choices about the critical financial issues involved in your divorce.
That’s why working with an experienced attorney is so important when making divorce-related decisions. The terms in your divorce settlement and decree will impact everything from your daily budget to your tax burden. In fact, divorces can lead to changes of thousands of dollars when it’s time to pay taxes next year. Here’s what you should know about tax considerations in California divorces and how they could affect you.
1. Taxes and Spousal Support
The way the IRS views spousal support payments, or alimony, has changed significantly in recent years. Before 2019, spousal support was considered taxable income for the recipient and tax-deductible for the paying party. This is no longer the case.
As of January 1st, 2019, all new or modified spousal support orders are subject to new rules. The Tax Cuts and Jobs Act states that alimony paid under orders changed or modified after this date is not taxable for the recipient. In addition, it is not deductible for the paying party.
This may significantly impact your taxes once the order goes into effect. If you’re the one paying alimony, it will be considered taxable even though you do not have the right to spend it however you wish. In contrast, you don’t have to worry about taxes taking a chunk of the funds if you’re receiving support. When negotiating your settlement, your attorney will help you take the new alimony taxation rules into account to determine how much spousal support should be paid.
2. Taxes and Child Support
Child support is another major financial concern in most divorces. Under federal tax law, child support recipients are not taxed on the funds they receive. As with spousal support, the paying party cannot deduct the funds and must pay taxes on them as if they spent the money themselves.
This makes more sense to most people than the spousal support change. After all, the money is not supposed to be used for the receiving parent’s benefit. Instead, it is treated as the paying parent’s expected contribution toward raising their children. The assumption is that the paying parent would be spending the amount they are ordered to pay on their children if there was no order. Since funds spent to raise children are not deductible for parents who remain married, support ordered by the court isn’t deductible either.
3. Deductions for Dependents
One of the most valuable tax benefits available is the ability to claim your children as dependents. Since tax year 2018, parents have been eligible to claim a $2,000 Child Tax Credit for their first eligible dependent child and a $1,500 credit for each additional one. These credits directly reduce your tax burden. You can receive the remainder as part of your tax refund if you owe less than your total credit amount.
However, when parents divorce, the tax credit is not shared. Only the parent with primary custody can claim their kids as dependents. When custody is shared, the parent at whose household the kids sleep more often is considered the primary. You should keep this in mind when negotiating your custody order and parenting plan, or your bill may look very different in April.
4. Filing Status
Once your divorce is finalized, you are no longer eligible to file taxes as a married person. You must file as single instead, beginning the tax year in which your divorce is completed. This may significantly alter your tax bracket if there was an income discrepancy during your marriage.
Couples with significantly different incomes often benefit from the so-called “marriage benefit” when they file. A single person who makes $200,000 in 2023 is subject to the 32% federal income tax. However, a couple whose total annual income is $200,000 falls into the 24% bracket. This is true even if one person makes all the money and the other is a stay-at-home parent with no income.
As a result, the higher-earning spouse may pay more in taxes each year. In contrast, lower-earning spouses often pay less.
5. Property Settlements
If you have high-value assets, such as real estate or a stop portfolio, you must consider capital gains taxes when dividing your property. For instance, the IRS grants married couples a joint $500,000 capital gains exclusion for profits earned on the increase in the value of a primary residence. However, an individual only receives a $250,000 exclusion. If you want to sell your house, it’s better to sell it the year before your divorce is finalized rather than awarding it to one person or selling it later. This could potentially save you tens of thousands of dollars in taxes.
Talk to a Skilled Divorce Attorney to Avoid Unpleasant Surprises at Tax Time
Divorce is an emotional process, but you cannot let your emotions lead you to ignore its financial impact. The best way to make better decisions during your divorce is to work with an experienced attorney.
At the Law Offices of Diane J.N. Morin Inc., we’re here to help. We have decades of experience untangling the financial and legal ramifications of complex, high-asset divorces in California. We can help you understand the tax consequences of your split and negotiate or litigate your split to achieve a fair outcome. Schedule your consultation with our Palo Alto family law firm to learn how we can assist you.
