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 it in your financial analysis. Before signing your divorce decree, understand tax effects on these 5 items: alimony, lump sum payment, child support, healthcare and retirement.
Alimony (also known as spousal support) is tax deductible to the person paying it. Alimony is taxable to the person receiving it. Your divorce decree must require these payments in order to qualify as alimony for federal tax purposes.
2- Lump Sum Payment
Lump sum payment may be used to split assets. However, if you receive a large lump sum payment you may be pushed into a higher income tax bracket.
3- Child Support
Child support is NOT tax deductible to the person paying it. Child support 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- Healthcare Insurance
Healthcare insurance is a requirement since the Affordable Care Act. If you lose your health insurance coverage due to divorce, you are required to purchase health insurance for yourself and for dependents you claim on your taxes. If you do not purchase coverage, you will pay a penalty when filing your income taxes.
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), then a Qualified Domestic Relations Order (QDRO) is required. QDRO is a separate legal document which needs to be executed prior to signing 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 major impact on your finances. Before signing any divorce decree, take time to understand what your total financial picture will look like post-divorce, including taxes.
ABOUT THE AUTHOR:
Niv Persaud, CFP®, CDFA™, CRPC®, is the Founder of 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 as a financial adviser. Her services include spending plan, financial plan, divorce financial review, life strategy and professional progression. 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’.”