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Divorce and Your Tax Liabilities

tax, Wheaton divorce attorneyDivorce causes changes in multiple areas of a person’s life, but one that is often overlooked is a spouse’s tax bill. Regardless of the time of year when you divorce, your next tax return is likely going to be affected by such a profound life change. You will likely lose certain exemptions and deductions, but you may also gain some. The important thing is to ensure an active role in how your divorce decree is written, so you can have as much control as possible over the tax consequences for both you and your ex-spouse.

Alimony and Child Support

Perhaps the most unpleasant surprise for so many is the tax consequences of alimony and child support. While the parent with the majority of the parenting time will be granted child support in all but the most unusual Illinois divorce cases—child support is a duty owed to the child or children, not to the ex-spouse—alimony or spousal support is a different matter. To determine whether such payments are warranted, the court will consider a host of factors, such as the income of both parties, the amount of support given during the marriage if one spouse had to leave the workforce for some reason—including giving birth or obtaining an advanced degree—and the actual current needs of each spouse.

The potential issue is simple: periodic maintenance, which is spousal support paid in increments over time, is taxable as income for the recipient and tax deductible for the payor. Child support is not taxable as income for the recipient and not deductible for the payor. As such, a significant maintenance award can cause serious tax consequences for a parent. One of the listed factors that a court will consider in awarding maintenance is the tax consequences, but not every court will actually consider them, or the court may consider the other factors to hold more weight than the alleged tax burden would be.

Child-Related Deductions and Credits

The other major concern for many divorcing couples is who gets to claim the exemption for any children of the marriage. Depending on your income, claiming the exemption may save you as much as $1,000 per minor child, and as such, it can be a very big help for divorced parents in lower tax brackets. Since 1997, being able to claim the exemption also means the ability to claim the child tax credit, as well as “scholarships” if you are paying tuition for one or more college-age children.

The exemption may be traded to the other parent if it would benefit them more. The exemption is valuable to those with incomes on the lower side, generally, as incomes over about $100,000 will price themselves out of any benefit, but other credits like the child care credit must remain with the custodial parent. Some parents misunderstand the value of the exemptions, or try to fight for them out of some kind of misplaced pride, but the best policy is generally to negotiate something in return for such exemptions if you would receive no benefit from using them.

Need Help Understanding Potential Tax Consequences?

Divorce is difficult enough without having to potentially make significant changes to your financial siutation. If you need assistance navigating the potential pitfalls, our experienced DuPage County divorce attorneys can help. Contact our offices today to set up an initial consultation.





The Tax Consequences of Divorce

Ordinarily, the transfer of property comes with some sort of tax consequences. Since divorces can involve a lot of property transfer, you might expect complicated taxes surrounding them. Fortunately, the IRS exempts from taxation most property exchanges that take place in a divorce; however, appreciated assets, like stocks, and retirement accounts both come with particular tax issues.

 Tax consequences of divorce IMAGEGeneral Tax Rules

Section 1041 of the Internal Revenue Code governs transfers between spouses and transfers related to divorces. The law generally exempts transfers so long as the transfer happens prior to the finalization of the divorce. The code also excuses transfers made after the divorce, so long as they are “incident” to it. A transfer counts as incident when it occurs within one year of the end of the marriage, or within six years of the end of the marriage if the divorce agreement requires such a transfer.

Appreciated Assets

Unlike most possession, assets that have appreciated in value, like stocks, can cause tax issues if a spouse transfers them during a divorce. While no one owes taxes when the spouse transfers the stock, taxes do come due when the recipient spouse decides to sell. Exactly how the IRS taxes the stock depends on how long the spouses held it. If they held it for more than a year between them, then the IRS taxes the appreciation as a capital gain. Note that the clock for the year begins to run when the first spouse purchases the stock, not when they transfer it in the divorce. This means that, after taxes, appreciated assets can be worth less than an equal amount of cash, since the recipient spouse will owe the capital gains tax when they decide to sell it.

Retirement Accounts

Transferring retirement accounts like IRAs can also come with serious tax consequences if not done correctly because the IRS places a penalty tax on early withdrawals from IRA accounts. This means that a spouse who simply withdraws cash from their IRA, and then gives it to the other spouse will incur a 10 percent tax on the money that they give away. Fortunately, transfers of an IRA can qualify as tax free under section 1041. Assuming that the transfer occurs incident to a divorce, then the spouse can move their money into a new IRA account in the recipient spouse’s name in order to avoid the penalty tax.

Legal Help

Divorces can be challenging and complex to navigate on your own. Contact an experienced DuPage County divorce lawyer today. Their knowledge can help you as you make your way through this difficult process.