During a divorce many people are understandably upset and often focused on children and immediate financial concerns, like support and asset division. The last thing they want to think about is a tax issue. This can be a mistake as the tax code impacts everything we do each day, especially in divorce. Understanding how divorce affects your tax situation is not just smart financial planning – it is essential protection.
How taxes can impact marital assets
In New Jersey, courts follow equitable distribution principles, dividing marital property fairly but not necessarily equally. This approach aims for fairness but does not automatically account for the tax consequences of different asset divisions.
Common issues with considerable tax implications include child-derived tax benefits, alimony, medical issues, and division of assets and debts.
Children
There are multiple child-related tax issues, such as which parent claims the child as a dependent and which parent files as head of household. Some other issues include the earned income credit, education credits, and tax benefits related to work-related childcare. Tax considerations involving children are numerous and significant and must be carefully addressed during divorce proceedings.
Alimony
Many people do not realize that the tax code changed in 2019. After 2019 in New Jersey divorce cases, the party receiving alimony does not declare it as income and the person paying is not allowed to deduct the amount paid from taxation. This change, consistent with the Tax Cuts and Jobs Act, means that paying or receiving alimony has no impact on potential tax credits or liabilities.
Medical Issues
The division of Health Savings Accounts (HSA) also presents tax-related issues. Understanding whether transferring an HSA is considered a taxable or non-taxable transfer can be crucial in facilitating the settlement of a divorce case.
Assets and Debts
Real estate
Many divorcing couples sell their shared home. This sale may qualify for capital gains tax exclusion, but specific requirements must be met. Unfortunately, many people fail to take advantage of this valuable tax benefit because they are not aware of the qualification criteria.
Retirement and Investment Accounts
The tax implications for the division of retirement accounts depend on multiple factors, including the type of retirement account and the age of the parties. Certain retirement accounts can be divided by effectuating penalty-free transfers using a Qualified Domestic Relations Order (QDRO). However, not all retirement accounts are eligible for penalty-free transfers.
When dividing investment accounts during a divorce, remember that two accounts showing the same dollar amount might be worth very different amounts after taxes. While there is typically no tax impact at the time of division pursuant to divorce, some accounts will be subject to capital gains tax or income tax when later withdrawn.
Businesses
There are many ways to divide a jointly owned business during a divorce case. You can sell it and split the proceeds, one spouse can buy the other’s share, or both can agree to continue running it together. The route you choose to go will have tax implications which can significantly impact the actual value each spouse receives. Moreover, to achieve a fair and equitable divorce settlement, it is essential to understand how tax code changes affect the value of any business assets being divided.
Conclusion
These are just a few examples of how the tax code impacts divorce. Tackling complex tax issues during divorce requires thoughtful planning. It is critical to work with a law firm with substantial experience handling the tax aspects of a divorce. A skilled divorce attorney with financial knowledge can help you evaluate settlement options based on true after-tax values, potentially saving and/or earning you thousands of dollars.
