Divorce and Taxes: Expect Changes

Many people think since they are paying child support they should get to deduct the support off their income for tax purposes and/or claim the child as a dependent. They are surprised when they find out they can't do that.

The custodial parent -- the one who has the child most of the time -- under the tax rules is entitled to claim the child as a dependent and receive the corresponding deduction unless the parents agree otherwise. Also, the receipt of child support does not constitute taxable income and is not deductible by the parent who pays the support.

Parents cannot share a single deduction. That's why it's important for parents to discuss and negotiate who will be entitled to claim the children as dependents. Often, if there are two children, each parent will claim one child as a dependent, and they may alternate years if there is only one child or an uneven number of children. Also, the custodial parent is entitled to file as head of household which is a much more favorable status than filing as a single person.

Maintenance payments, often referred to as alimony, are for support of a spouse. The person paying maintenance receives a tax deduction for the amount paid while the person receiving it is taxed on that support. Tax money can often be saved because income is being transferred from a higher tax bracket to a lower tax bracket. However, the receiving party needs to be clear that all of the money will be taxed and probably needs to pay quarterly estimated income taxes.

There may be some tax consequences from the sale of a house, if the sale does not qualify as the primary residence for the parties. For other assets, such as stocks, bonds, rental properties and the like, the capital gains tax rules will apply and be due in the year of sale.

Retirement funds are often one of the largest assets the parties may have and therefore need to be divided between the parties. The easiest way to avoid tax consequences at the time of the divorce is to use a document called a Qualified Domestic Relations Order to divide the 401(k) or pension or other retirement accounts. The parties may then have the option of keeping the assets invested where they are or rolling the assets over into another retirement fund. If done properly, taxes can be avoided at the time of divorce, and only become due upon withdrawal of the funds at the time of retirement.

However the assets and child responsibilities are divided in a divorce, couples should double check all of the tax consequences to make sure that each of the parties understands his or her income tax consequences and to ensure that the most strategic approach to tax planning is taken.


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