The Tennessee Department of Health reported 22,359 divorces in the state in 2020. For each of these couples, one change they had to eventually navigate was taxes.
Understanding the tax implications of divorce is important to avoid issues when tax time comes around because the IRS is watching.
Filing status
The marital status as of December 31 of the tax year determines whether individuals can file as married or single. If a couple finalizes their divorce by the end of the year, they typically will file as single or head of household. However, if the divorce is still pending, they can file jointly or married filing separately.
Dependents
Claiming dependents is another aspect influenced by divorce. Typically, the custodial parent claims the child as a dependent for tax purposes. The custodial parent may also claim tax credits and deductions related to the child, such as the Child Tax Credit and the Earned Income Tax Credit. However, most divorce agreements will specifically address who gets to claim the children each tax year.
Assets
The transfer of assets between spouses in divorce is generally tax-free. However, when selling assets as part of the divorce settlement, capital gains taxes may apply. There is an exclusion for the sale of the marital home under certain conditions. However, retirement accounts are not immune to the tax consequences of divorce unless there is a Qualified Domestic Relations Order.
Divorce introduces significant changes to one’s financial landscape, and understanding the tax implications is important. Taking the time to comprehend the changes helps individuals make informed decisions and plan properly.