Divorce can be an emotionally and financially taxing experience that brings up unforeseen complexities, particularly regarding the tax implications of their decisions.

Understanding how divorce affects taxes is important, especially in Maryland, where state-specific regulations intersect with federal tax laws. Here’s an in-depth look at what you need to know.

The Tax Filing Status: Timing Matters

One consideration during a divorce is determining your tax filing status. The filing status you choose can significantly affect your tax liability. The Internal Revenue Service (IRS) bases your filing status on your marital status as of December 31st of the tax year.

If your divorce is finalized by the end of the year, you can no longer file as Married Filing Jointly or Married Filing Separately. Instead, you’ll likely file as Single or, if you qualify, as Head of Household. Filing as Head of Household often results in a lower tax rate and a higher standard deduction, but you must meet specific criteria, including maintaining a household for a qualifying child.

It’s important to consult with a tax advisor or a family law attorney early in the divorce process to determine the best course of action for your specific situation.

Alimony and Taxation: Post-2019 Changes

Alimony, or spousal support, is a common component of divorce settlements. However, changes introduced by the Tax Cuts and Jobs Act (TCJA) of 2017 have significantly altered the tax treatment of alimony.

For divorce agreements executed on or after January 1, 2019, alimony payments are no longer deductible by the payer spouse, nor are they considered taxable income for the recipient spouse. This shift represents a significant departure from previous tax law, where the payer could deduct alimony payments, and the recipient had to report them as income. If your divorce was finalized before 2019, the old tax rules still apply unless the divorce decree was modified to incorporate the new law.

This distinction  can have a significant effect on negotiations around spousal support. The non-deductibility of alimony may lead to different strategies in divorce settlements, including alternative forms of financial support.

Child Support: Non-Taxable and Non-Deductible

Child support payments are treated differently from alimony under tax law. Regardless of when your divorce was finalized, child support payments are neither deductible by the payer nor taxable to the recipient. The purpose of child support is to cover the child’s living expenses, and the IRS does not consider these payments as income.

Because child support is not tax-deductible, parents paying both alimony and child support must carefully consider how these payments are structured during divorce negotiations. It’s often beneficial to work with a legal professional to ensure that the settlement is tax-efficient and serves the best interests of all parties involved.

Division of Assets: Taxable Events and Considerations

The division of marital assets is another critical area where tax implications arise. Maryland is an equitable distribution state, meaning that marital property is divided equitably but not necessarily equally. When dividing assets, it’s important to consider the tax basis and future tax liabilities associated with each asset.

For example, transferring a retirement account from one spouse to another as part of a divorce settlement can have significant tax consequences if not handled properly. A Qualified Domestic Relations Order (QDRO) is typically required to divide retirement accounts like a 401(k) or pension plan without triggering taxes or penalties.

Similarly, the sale or transfer of real estate, such as the family home, may result in capital gains taxes. However, under certain conditions, spouses may qualify for an exclusion of up to $250,000 ($500,000 for married couples) on the gain from the sale of a primary residence, provided they meet the ownership and use requirements. Understanding the tax basis of the property and how any capital gains will be taxed can help you negotiate the division of real estate in the most advantageous way possible

Tax Implications of Debt Division

Debt division is another aspect of divorce that can carry tax implications. For instance, if one spouse is responsible for paying off a joint debt, such as a mortgage or credit card, it’s important to clarify how interest payments will be handled for tax purposes.

If debt is forgiven as part of the divorce settlement, it may be considered taxable income by the IRS. This is particularly relevant in cases where one spouse agrees to assume a larger share of the debt in exchange for other assets. 

Impact on Tax Credits and Deductions

Divorce can also affect eligibility for various tax credits and deductions. For example, only one parent can claim the Child Tax Credit or the Dependent Care Credit for a qualifying child. Typically, the custodial parent—the one with whom the child spends the most nights during the year—claims these credits. However, parents can agree to alternate years or negotiate other arrangements in the divorce decree.

The Earned Income Tax Credit (EITC) is another consideration, as it is only available to the parent with primary custody. Additionally, the division of medical expenses and how they are reported on tax returns should be addressed during divorce proceedings.

Seek Professional Legal Guidance

The intersection of divorce and taxes is complex, with many nuances that can significantly impact your financial future. In Maryland, where state laws intersect with federal tax regulations, it is especially important to approach divorce with a clear understanding of these implications.

Consulting with an experienced family law attorney in Bel Air, Maryland at Rodier Family Law can help you structure your divorce settlement in a way that minimizes tax liabilities and protects your financial interests. 

Contact us today if you are in need of legal assistance.