When going through a divorce, the last thing you want to think about is taxes.
But it could be costly if you don’t include them in your financial analysis.
Before signing your divorce decree, take time to understand the tax effects on these five items.
1- Alimony
For divorces dated January 1, 2019, or later, alimony (also known as spousal support) is no longer tax-deductible to the person paying it.
Also, it is no longer taxable for the person receiving it.
Your divorce decree must clearly specify the amount of spousal support and when it ends.
2- Lump Sum Payment
When assets cannot be easily liquidated (e.g., real estate), a lump sum payment can settle the difference.
Be aware that you may move into a higher income tax bracket if you receive a significant lump sum payment.
3- Child Support
Child support is NOT tax-deductible to the person paying it.
And, it is NOT taxable to the person receiving it.
Be aware of IRS regulations regarding the timeframe between when child support and alimony payments cease.
4- Health Insurance
Health insurance has been a requirement since the Affordable Care Act.
If you lose health insurance coverage due to divorce, you’re required to purchase it for yourself.
If you do not purchase coverage, you’ll pay a penalty when filing your income taxes.
Also, you’ll need to include coverage for your dependents if your spouse’s insurance doesn’t cover them.
5- Retirement Assets
Retirement assets may come from different accounts.
If retirement assets come from a qualified retirement plan (e.g., an employer-sponsored 401(k) plan), you’ll need a Qualified Domestic Relations Order (QDRO).
A QDRO is a separate legal document that needs to be executed prior to signing your divorce decree. Some employers do not honor divorce decrees – it’s better to know this information before you finalize your divorce decree.
Internal Revenue Code Section (72)(t)(2)(C) allows money to be taken out of a qualified retirement plan without an early distribution penalty of 10%.
Additionally, by transferring money from a qualified plan directly to your IRA (not taking a distribution), there will be no ordinary income tax.
Any contribution to a spouse’s IRA will not be deductible if you are divorced by December 31 (the date IRS uses to determine your marital status for the year).
Divorce has a significant impact on your finances.
Most attorneys will examine your current assets. But they will not consider the tax effects of settlements and your future lifestyle financial needs (e.g., major home repairs, retirement, etc.).
Before signing your divorce decree, take time to work with a financial advisor to understand both the tax implications of your settlement and your post-divorce financial needs.
This information will provide the justification for the amount you need from your marital assets and future support.
(Update to original post from August 25, 2015)
ABOUT THE AUTHOR:
Niv Persaud, CFP®, CDFA®, RICP®, is a Managing Director at Transition Planning & Guidance, LLC. Life is more than money. It’s about living the lifestyle you want and can afford. For that reason, Niv consults with clients on money, life, and work. Her approach capitalizes on techniques she learned throughout her career, including as a management consultant, executive recruiter, and financial advisor. Her services include developing comprehensive financial plans, divorce financial reviews, and retirement plans. Niv actively gives back to her community through her volunteer efforts. She believes in living life to the fullest by cherishing friendships, enjoying the beauty of nature and laughing often — even at herself. Her favorite quote is by Erma Bombeck, “When I stand before God at the end of my life, I would hope that I would not have a single bit of talent left and could say ‘I used everything you gave me.’”