Could these overlooked tax breaks after divorce save you money?
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If you're ending your marriage, add filing taxes after divorce to the list of headaches that you’ll need to deal with. First, if you haven't already done so, you need to file a new W-4 form with your employer to adjust the amount withheld from your paycheck.
But that's not all. You might also be facing alimony payments, child custody arrangements, home sales, and other divorce-related issues that can affect your taxes.
To help with these issues, here are seven often overlooked tax tips and potential tax breaks to consider when you are filing taxes after divorce.
Your marital status as of December 31 controls your tax filing status. So, if you split up, but aren't officially divorced before the end of the year, you can still file a joint return (which is likely to save you money) or choose the married-filing-separately status for the tax return you file for the year that you separate.
You can also file as head of household if you lived apart from your spouse for the last six months of the year, file separate returns, had a dependent living with you for more than half of the year, and paid more than half of the upkeep for your home.
Once you are divorced, you can file as a head of household (if you have a dependent living with you for more than half of the year and you pay for more than half of the upkeep for your home) or as a single taxpayer.
Your filing status can have a significant impact on your tax liability. For example, income tax brackets differ for each filing status, and so do standard deduction amounts.
Here are the 2023 standard deduction amounts for each filing status:
You can generally deduct alimony you pay to a former spouse if the divorce agreement was in place before December 31, 2018. (If you’re the receiving spouse, you must include alimony or separation payments in your income.)
However, you cannot deduct alimony under divorce or separation agreements that were signed after December 31, 2018. Otherwise, it's not deductible (or taxable to the recipient). You also lose the deduction if the agreement is changed after 2018 to exclude the alimony from your former spouse's income.
To qualify as deductible alimony, the cash-only payments must be spelled out in your divorce agreement. You're required to report the Social Security number of your ex-spouse, too, so the IRS can make sure that your former spouse reports the alimony as taxable income.
Generally, only the custodial parent (the one the kids live with most of the year) can claim the child tax credit or credit for other dependents for a divorced couple's qualifying children.
The 2023 child tax credit (for tax returns filed in early 2024) is $2,000 per child 16 years old or younger. Children who are too old for the child tax credit may qualify for the credit for other dependents, which can be as high as $500 per qualifying dependent.
What many people don't know is that it's legal for the noncustodial parent to claim one of these credits for a child if the other parent signs a waiver agreeing not to claim an exemption for that child on their own tax return. That means the custodial parent can't claim the credit. Form 8332 must accompany the noncustodial parent's return each year that they claim the tax credits for the child.
This approach could make financial sense if, for example, the noncustodial parent is in a higher tax bracket than the custodial parent.
If you continue to pay a child's medical bills after the divorce, you can include those costs in your medical expense deductions even if your former spouse has custody of the child. However, you must itemize deductions to do so. That means you can't take the standard deduction in the same tax year that you deduct medical expenses.
Additionally, medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income, but the child's bills that you pay could push you over the 7.5% threshold.
When a divorce settlement shifts property from one spouse to another, the recipient doesn't pay tax on that transfer. That's the good news.
But it's important to remember that the property's tax basis shifts as well. So, if you get property from your former spouse in the divorce and later sell that property, you will pay capital gains tax on all the appreciation before, as well as after, the transfer. That's why, when you're splitting up property, you need to consider the tax basis as well as the value of the property.
If, as part of your divorce, you and your former spouse decide to sell your home, the timing can have tax consequences. Normally, the law allows you to avoid tax on the first $250,000 of gain on the sale of your primary home if you have owned the home and lived there at least two years out of the last five. Married couples filing jointly can exclude up to $500,000. For sales after a divorce, if the two-year ownership-and-use tests are met, you and your ex can each exclude up to $250,000 of gain on your individual returns.
If the two-year tests haven't been met, sales of a home after a divorce can still qualify for a reduced exclusion. The limit on tax-free profit in this case will depend on the portion of the two-year period for which the home was owned and used.
If, for example, it was one year instead of two, you each can exclude $125,000 of gain. What happens if you receive the house in the divorce settlement and sell it several years later? Then you're stuck with the $250,000 maximum.
Generally, a taxpayer must have earned income from a job or self-employment to qualify to contribute to an IRA. However, there's an exception for some divorced people.
Taxable alimony you receive counts as compensation for the purposes of making IRA contributions. For 2023, you can contribute up to $6,500 to a traditional IRA a Roth IRA, or a combination of the two. The 2024 IRA contribution limit jumps to $7,500.
If you're at least 50 years old, you can contribute an additional $1,000 for the year (for a total of $7,500 for 2023 and $8,000 for 2024.
