There are a lot of moving parts going on at once in a divorce case – calculating child support and maintenance, determining a parenting time schedule and who makes decisions for the children, figuring out how to divide assets and debts, selling real estate, determining dissipation, and so many other variables. The last thing on your mind is probably one of the most important to address during the divorce process: tax issues.
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5 Important Tax Implications in a Divorce
Here are the most important areas and issues to consider in your divorce case that deal with tax implications:
1. Filing taxes during the divorce process and after:
You and your spouse will need to address the issue of how taxes will be filed during the divorce. Most of the time, even if you are living separately and the children might be living with one parent more of the time than the other, it is financially better for you and your spouse to file joint tax returns as you get to maximize the standard deduction and reduce the taxes required to be paid. You can still file joint taxes for a tax year so long as you are still legally married when that year ends. However, if you get divorced at any time during the year, then that year you will need to file separate tax returns. Once the divorce is finalized, you will need to file single or head of household. If there are minor children, and they are living with you for at least 50% of the year, you can file as head of household to maximize your tax savings. Be sure to talk to a qualified accountant and/or tax preparer to ensure your taxes are accurate and that you are getting all the tax savings you are entitled to.
2. Property Division
Generally speaking, transfers of property between spouses during and after a divorce, based on terms of the final judgment for dissolution of marriage, are tax-free. However, there can be tax consequences if property is sold during the divorce process. If you or your spouse sell investments, cryptocurrency, or stocks, there can be additional taxes based on capital gains. If you and your spouse agree, or the court orders it, the marital residence can be sold during the divorce as well. Some of the profits from the sale might be excluded from capital gain tax, but that depends on other factors as well. You will want to hire an accountant or tax preparer to better help you understand what taxes you need to consider when property is sold, and how you can limit your capital gain tax, whether filing separately or jointly.
3. Retirement Accounts
Transferring retirement funds based on a divorce judgment does not normally result in additional taxes. If IRAs or 401(k) accounts are being divided, an order called a Qualified Domestic Relations Order (QDRO) gets entered at the time of the divorce. This order directs the retirement plan administrator to segregate out funds for the other spouse and put them into an account in that spouse’s name, or roll them over into that separate account. Sometimes there are also transfer orders with certain companies that can effectuate this split as well. Once the funds are in an account in your name, any funds you might withdraw from the account if you are not of legal retirement age will cause additional fees and tax penalties. So, if you were planning to use funds from your spouse’s retirement account to pay your bills or debts, or just have it as income, you should re-think that if you are not prepared to pay the taxes and fees that are associated with using those funds before retirement age.
4. Family or Marital Business
If there was a business opened and operating during the marriage, this will have to be divided as well, or sold. If one spouse is keeping the business, this too can be transferred to that spouse incident to the divorce without additional taxes. However, if the business is sold during the divorce, there will be capital gain taxes for you and your spouse that you will need to consider. If you are the spouse being awarded the business in the divorce, it is wise to hire a tax preparer and accountant for your business to help keep track of business revenue, debts, corporate taxes that might be owed, tax deductions, etc.
5. Child Tax Deductions and Credits
During the marriage, you and your spouse both got the benefit of a deduction or child tax credit(s). However, it will have to be determined who will get those deductions and credits after the divorce on their taxes. If one parent has the majority of parenting time, they generally will get to claim the child or tax credits, however, if the other parent is paying child support timely, this deduction or tax credit could be alternated every year. If there are multiple children, who claim the children, the deductions can be split every year, or one parent can claim one child every year, etc. Which spouse gets the tax benefits can vary based on the case and the facts, so be sure to discuss this with your divorce attorney. Claiming the child or children on your taxes can help reduce your taxable income, so it is important to determine this.
After your divorce is finalized, you should consult with your accountant and/or tax preparer to ensure that they are aware of any changes in your situation and can assist you in obtaining the best possible tax benefits.
Get Advice from a Chicago Divorce Attorney
The attorneys at Anderson Boback & Marshall have in-depth experience in all aspects of divorce and family law, including tax issues in a Chicago divorce. Please contact Anderson Boback & Marshall for questions about this topic and other questions related to Illinois divorce or family law.
