If you're going through a divorce, taxes may be the last thing on your mind. But divorce involves many potential tax traps and pitfalls. Here are some things to know.
- Alimony and child support. Alimony is taxable income to the person who receives it and deductible by the person who pays it, as long as it meets certain specific tax requirements. Child support is neither taxable nor deductible. A divorce agreement should clearly spell out the difference between alimony and child support.
- Property settlement. When a divorcing couple agrees to a property settlement, there are no immediate tax consequences. But when it comes time to sell the property, one of the parties could be in for a nasty tax surprise. That's because each spouse receives property with its original tax basis, and a low tax basis may trigger a large capital gain down the road. A truly equitable property settlement should consider the tax basis of assets, not just current market value.
- Children. After divorce, the parent who has custody of a child for the greater part of a year generally has the right to claim that child as a dependent. However, the custodial parent may transfer the dependency exemption to the other parent by signing the appropriate IRS form. Why would you ever give away a deduction? Because it may be worth more to your ex-spouse. In exchange for the dependency deduction, you may be able to bargain for more alimony or a larger property settlement.
- Tax filing. As a married couple, you probably have been filing a joint tax return. But during divorce proceedings, you may be better off filing separately or, if you qualify, as head of household. Once the divorce is final, your filing status will be either single or head of household. To qualify as head of household, certain requirements for dependents must be met.
Marital status is an important factor in the amount of taxes you will pay. Be aware that in divorce situations some planning might cut your taxes significantly.