When couples get divorced, they need to divide their assets and debts in a process called equitable distribution. It’s not always a straight 50/50 split, but rather what’s most fair based on the couple’s situation. How you divide your assets affects more than your divorce, however. It can also affect your tax bill.
If you’re ending things with your spouse, it’s important to ask about the tax considerations and do what you can to avoid paying too much to Uncle Sam. However, tax laws, both federal and state, are complicated and frequently changing. This can make it hard to figure out exactly how these laws apply to your divorce situation.
At Untying the Knot, we know that every divorce is different, and our goal is to help you make informed, tax-efficient decisions about your assets. In this blog, we’ll explore tax considerations for equitable distribution and the benefits of having a smart strategy.
The process of dividing assets and liabilities isn’t a one-size-fits-all. Courts look at what each spouse brought to the marriage, what was earned or accumulated during the marriage, and what is needed for a stable future post-divorce for both spouses.
First, there’s a need to determine what’s considered marital property and what’s separate. Marital property includes most assets and debts gathered during the marriage, while separate property is what each person had before the marriage or received individually as a gift or inheritance.
The actual division involves several steps:
Sometimes, one person might get more of the assets if, for instance, they earn less or have custody of the children. Other times, debts and assets might be split based on who benefited more from them during the marriage.
Here’s what you need to know about the tax considerations in equitable distribution.
If you’re splitting up assets worth more now than when you bought them, keep in mind that selling these items could mean paying capital gains tax. This tax is on the profit you make from selling something that has increased in value.
There are different tax impacts when a property changes hands during a divorce. For instance, if you transfer a property to your ex-spouse, you won’t pay taxes immediately. However, if they sell it later, the taxes will be based on how much the property was originally bought for. Also, the timing of when you sell or transfer property can change the tax consequences.
While retirement accounts and pension plans are substantial assets in a divorce, dividing them can be tricky due to tax rules. You might need a legal document called a Qualified Domestic Relations Order (QDRO) to split these accounts without incurring immediate taxes.
In a divorce without court, some assets are treated more favorably by tax laws, meaning they can lead to lower taxes now or in the future. A few examples include:
To make the most of these tax-advantaged assets, you must:
Getting the value of your assets right is key to a fair divorce settlement. You must figure out how much each asset is worth. If the values are off, you might end up paying more or less in taxes than required.
Different assets need different valuation methods:
The Tax Cuts and Jobs Act of 2017 (TCJA) brought significant changes to how alimony is treated for tax purposes.
Since alimony is no longer tax-deductible, here are some strategies to help lower the tax impact of these payments.
Child support, like alimony, is non-taxable. This means you cannot deduct it from your income. Usually, the parent who has custody of the children for most of the year gets to claim them as dependents on their tax return. This can lead to tax benefits, like credits for childcare expenses.
But sometimes, parents might agree to let the non-custodial parent claim the kids. It’s important to decide this and include it in your divorce agreement.
A Qualified Domestic Relations Order, or QDRO, is a legal order that lets you split up and distribute retirement accounts, like 401(k)s or pensions, between you and your ex-spouse without triggering immediate taxes or penalties.
A QDRO tells the company managing the retirement account how to split it between the divorcing couple. But remember, if you split the retirement account, both you and your spouse will have to pay taxes on the money when you use it, depending on the account type.
When you’re dividing assets in a divorce, it’s smart to have a plan for handling taxes. Here’s how to do it.
By thinking about taxes in advance, you can better manage your money during and after the divorce. The aim is to get a fair deal and understand how these choices affect your finances in the long run.
Ready to navigate the financial complexities of your divorce with confidence? Visit Untying the Knot for guidance and resources tailored to your unique situation. Contact us today.
At Untying The Knot, we focus on a kinder, gentler divorce – to allow you to move on with your lives more quickly, less expensively and with way less drama.