Tax considerations are rarely ever a driving force during divorce negotiations. But the tax implications of divorce can be significantly crippling for both spouses. This is especially true in regards to property distribution and spousal support. Fortunately, taking a strategic approach in considering these implications can mitigate the tax consequences of your divorce and help find resolutions in unexplored opportunities. Speaking with an experienced divorce attorney can greatly help you formulate your approach to dealing with these implications.
Below, we list 7 common tax issues that can potentially impact your divorce in California. To learn more, contact the Law Offices of Rick D. Banks today.
1. Alimony Tax Consequences
Unfortunately, under the new Tax Cuts and Jobs Act, payments made for spousal support are no longer deductible for divorces settled after December 31, 2018. This means that high-earning spouses no longer have a significant incentive to agree to pay alimony during divorce negotiations. On the flip side, former spouses that receive spousal support do not have to report those payments as taxable income. So, alimony will more than likely still play a significant role in divorce negotiations.
2. Property Transfers That Trigger Income Tax Liability
Most property transfers among spouses during divorce negotiations are exempt from income tax liability. However, there are certain types of transfers that can trigger income recognition. We strongly advise spouses to avoid the types of transactions that can result in needless liability to the IRS or the California Franchise Tax Board.
3. Tax Credits for Non-Child and Child Dependents
The Tax Cuts and Jobs Act eliminated dependents from personal exemptions through 2025. In addition, it also increased child tax credits from $1,000 to $2,000, as well as giving non-child dependents a $500 credit. We recommend that spouses factor these credits when calculating the obligations of financial support during divorce negotiations.
4. Splitting Retirement Plans
Avoid the negative tax implications of splitting retirement plans by obtaining a qualified domestic relations order (known as QDRO). While a QDRO is not required in dividing a non-retirement investment account or IRA, you should consider other tax implications for those accounts as well.
5. Impact on Business Valuations
The Tax Cuts and Jobs Act will have a meaningful impact on business valuations. This impact is due in part to the act’s reduction on income tax rates for business entities and corporations. This means a higher value on your business due to improved cash flow. We recommend that business owners apply current standards of valuation when going through the process of divorce.
6. Home Equity and Mortgage Deductions
Spouses that divorce in California must not only divide any community assets but also any shared debt. Consider available tax deductions or credits when you determine the prospect of assuming responsibility for any shared debt. However, keep in mind that those available deductions and credits can change.
7. Filing Status
If your divorce is not finalized before the year is up, you can file either with a joint return or under the “married filing separately” status. Filing a joint return may award you a reduction in tax liability, but it may also leave you liable for any omissions or errors your spouse makes. Furthermore, depending on your negotiations for child custody, you may qualify to file under “head of house” status. Filing under this status can lead to significant tax implications as well. Keep in mind that there is a six-month waiting period in California, so all of this is not possible if you file for divorce after July 1st.
Learn More About the Tax Implications of Divorce
For more information on tax implications of divorce in the state of California, consult a family law attorney at the Law Offices of Rick D. Banks today. Our seasoned legal team can help you effectively plan for any tax consequences that may arise from your divorce.