Divorce has a tendency to create major financial changes. Obviously, trying to support two separate households with the income that once supported a single home typically results in a reduced standard of living. Spouses also lose some of their resources during the property division process. Beyond that, they have to pay for the divorce itself.
Divorce proceedings can also influence income tax matters. Particularly during tax return season, those considering divorce or in the process of securing one may have questions about what their changing marital status means for their tax situation. There are several noteworthy ways that a divorce can affect income taxes, including the three below.
1. Filing status may need to change
Married couples typically file tax returns together, although they do not always do so. While they are in the process of divorce, spouses may decide to file tax returns using the status of married, filing separately.
However, there are often financial benefits available if they continue to file their tax returns jointly. After the divorce, spouses can file as single people or as the head of a household.
2. There are tax benefits associated with children
Parents preparing for divorce have to address many practical considerations. Income tax returns are one of them. Generally speaking, parents have to have a plan for who can claim the children when they file their annual income tax returns.
Most of the time, the parent who has more time with the children claims them for income tax purposes. However, the spouses may agree to an alternate arrangement. They may each claim certain children. They may alternate years. Sometimes, a higher-earning spouse may claim the children because it offers more financial advantages than having the primary caregiver claim them.
3. Asset division can affect taxes
Various aspects of the property division process can create income tax complications. If spouses liquidate investments, there could be tax implications. While transfers between spouses do not trigger tax liability, selling assets during or immediately after the divorce could.
Other times, withdrawals from tax-deferred retirement accounts might affect their annual income and therefore their tax obligations. If spouses don’t use the right paperwork, they may have to claim what they withdrew from those accounts as income.
People preparing for divorce proceedings may need help identifying and addressing income tax concerns. A change in marital status and household size can have a drastic impact on income tax obligations.