Tax implications of a California divorce
What are your tax implications when filing for a divorce?
Far too many people negotiate and finalize their divorce without taking proper account of the tax impacts. Here’s a quick summary of some of the issues we see people miss most often:
Checking the box for either married or single may seem like the simplest thing in the world, but it gets complicated with divorce. The IRS wants to know your legal marital status as of the end of the year you're filing for. So even if you've filed your paperwork, if your divorce isn't final by Dec. 31, then you'll be considered married for the year.
However, there's an exception that allows separated parents to claim the favorable head of household status, which gives you greater deductions. To qualify, you must have paid more than half your housing costs for the year, lived apart from your spouse during the last six months of the tax year, and your dependent child must have lived in your home for more than half the year.
Exemptions for Children
The question of who gets to claim exemptions for children can make a huge difference to your tax bill. Typically, the test depends on which parent the child lives with for more than half the year. But divorced or separated couples can essentially pick who gets the exemption for children by signing a written declaration. With the current write-off at $3,700 per child, the decision you make can determine which of you will get up to $1,300 in tax savings.
Alimony, Maintenance, and Child Support
Payments between former spouses under a divorce decree fall into different categories. Cash payments that qualify as alimony are deductible by the person who makes them and are counted as income for the person who receives them.
Child support, on the other hand, isn't deductible by the payer or counted as income by the recipient or the child. So as you describe certain payments in your divorce agreement, be careful because the description can change the way those payments get taxed.
As part of a property settlement, a spouse may be entitled to part of the other spouse's IRAs or employer-sponsored retirement account. For 401(k)s and other employer plans, a qualified domestic relations order can allow you to get benefits from a spouse's plan and treat them as if they're your own, thereby avoiding potentially disastrous tax consequences. Under certain circumstances, you may be able to roll 401(k) money into an IRA of your own.
In general, neither spouse will realize any capital gain or loss or other tax consequences from receiving or giving up property in a divorce decree. But if you later sell property that you received due to divorce, you'll then have to pay taxes on gains, based on the original tax basis of the property you received.
To be treated as part of the divorce, a property transfer must be complete within a year of the date the marriage legally ended, unless it was specifically provided for under the divorce agreement. In that case, you have up to six years to make transfers, although later ones may still be valid if you can show valid reasons for the delay.
Finally, California is a community property state, which means you may be treated as having earned a part of your former spouse's income during the year in which you divorce.
The problem here is that you may have no idea how much money your former spouse made. Accordingly, the IRS won't penalize you for mistakenly leaving out community property income as long as you can show that you had no reason to know about the income and that it wouldn't be fair to force you to include it as your own income.
The above information should not be considered as tax advice. Please consult your tax professional to answer questions specific to your situation.