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How do taxes impact a divorce?

On Behalf of | Feb 23, 2022 | Divorce |

Marriages may end and life will go on, but there will still be taxes to pay. For couples in Ohio and elsewhere who are planning to divorce or are considering their options, one thing they cannot afford to forget about is how the IRS will view their new financial state post-divorce.

Whether it is concerning property transfers, retirement accounts, or alimony or support payments, taking care of tax-related matters in divorce can be daunting challenge, especially when the upheaval involves complex financial holdings in a high-asset divorce. Residents of Cincinnati and surrounding areas can benefit from savvy tips on how to come out of it with their finances intact.

Avoiding unnecessary property transfer taxes

As Ohio is an equitable division state, the court will decide on a divorce settlement that is fair but not always equal when it comes to property division. Couples may want to find ways of transferring property that will have tax advantages.

Regarding retirement accounts, a qualified domestic relations order (QRDO) will in general not create tax issues if the transfer of a retirement plan is structured as an eligible rollover distribution. But both parties should pay attention to IRS regulations when handling withdrawals or rolling finds into another IRA. A trustee-to-trustee direct transfer will not have tax consequences.

Couples will often create property transfers between the two sides as part of a settlement agreement, which will usually not create tax headaches. They may want to consider other options, however, that offer advantages down the line.

Instead of transferring property during the divorce, they can create a taxable event by creating a “true sale” more than one year after divorce so that they can take advantage of an increased cost basis on the property. In this way, both spouses can benefit from capital gain exclusions.

Tax credits and support penalties

Claiming the children as tax credits can get contentious, especially if both spouses try to claim the dependent deduction. Whoever files first gets the credit, and it will be the second filer who has the burden of proving them wrong. Claiming Head of Household status is available to both spouses, however, as long as they are considered single on the last day of the year of filing.

As new tax laws have changed regarding child support and alimony payments, the spouse making payments can no longer receive a tax deduction for them. As a result, the courts have adjusted the measure of what a reasonable settlement should look like.

Finally, it is important to pay attention to potential tax credits. For example, a business owner who may have a tax refund coming due to an underperforming business or stock loss will be counting on this to offset current or future taxable income. It may make sense to filed as married filing separately, or even draw up an indemnification agreement for protection.