Divorce and separation can change your tax situation quickly. Before year-end (and before final agreements are signed), consider the key federal issues below and coordinate with your CPA and attorney.
Filing Status: Your Status on December 31 Controls
Your filing status generally depends on whether you are married on the last day of the year
- Divorce or legal separation final by December 31: typically file single or head of household (if eligible).
- Still married at December 31: choose married filing jointly or married filing separately.
- Possible head-of-household planning for certain married individuals living apart: a separate-return filer may be treated as unmarried in limited circumstances (including maintaining a home for a qualifying child and living apart during the last six months of the year).
Dependents and Form 8332
Dependency rules still matter for the child tax credit and other benefits, even though the personal exemption amount is currently zero.
- The custodial parent is generally the parent with whom the child spends more nights during the year.
- A noncustodial parent generally needs a signed Form 8332 (or similar written release) attached to the return to claim a child under the special divorce rules.
- Form 8332 typically helps transfer the child tax credit/dependency-related claim, but it generally does not transfer head-of-household status, earned income credit, or child-care related benefits.
Support Payments: Alimony vs. Child Support
- Alimony (most post-2018 agreements): generally not deductible by the payer and not taxable to the recipient; some modified pre-2019 agreements follow this treatment if the modification expressly adopts the newer rules.
- Child support: generally not deductible by the payer and not taxable to the recipient.
Property Transfers and the Home
- Property transfers incident to divorce: generally no immediate gain or loss; the recipient usually receives carryover basis (future tax may follow the asset).
- Home sale exclusion: generally up to $250,000 of gain can be excluded per eligible taxpayer (and up to $500,000 on a joint return if requirements are met).
- If one spouse moves out: special rules may help the nonresident spouse satisfy the use test if the other spouse is allowed to live in the home under a divorce or separation agreement.
Retirement Accounts and QDROs
- Employer retirement plans (e.g., 401(k)) are commonly divided using a QDRO. Distributions to a spouse/former spouse under a QDRO are generally taxable to the recipient spouse/former spouse.
- A QDRO recipient may be able to roll over eligible amounts to an IRA or other eligible plan (often best handled as a direct rollover).
- The 10% early distribution penalty generally does not apply to distributions under a QDRO, but penalty rules can change after rollover to an IRA; the QDRO penalty exception generally does not apply to IRA distributions.
Business Interests and Tax Attributes
If a divorce settlement includes an interest in an S corporation, partnership, or other closely held business, involve tax advisors early. Key issues often include:
- Carryover basis and built-in gain/loss on transferred interests
- Suspended losses and how they may (or may not) carry over, including S corporation loss limitations
- Partnership basis and liabilities, which can affect both spouses’ after-tax outcomes
- Suspended passive losses, which are often deferred rather than currently deductible in divorce transfers
Withholding, Estimated Taxes, and Cash Flow
Divorce commonly changes income, deductions, credits, and cash flow. Before year-end, review:
- Whether wage withholding and/or estimated tax payments still fit your new situation
- How any tax refunds, balances due, and prior estimated payments will be handled between spouses
Estate Plans and Beneficiaries
After a separation or divorce (and sometimes during the process), review and update as appropriate:
- Wills and trusts, powers of attorney, and health care directives
- Beneficiary designations on retirement plans, life insurance, and payable-on-death accounts
- Account titles and ownership (bank/brokerage and major assets)
Quick Year-End Checklist
- Confirm whether the divorce/legal separation will be final by December 31.
- Decide on filing approach (single/HOH vs. MFJ/MFS), and discuss any joint-return protections if considering MFJ.
- Confirm which parent will claim each child and whether Form 8332 is needed.
- Verify tax characterization of support (alimony vs. child support).
- Gather basis and tax attribute information for major assets being transferred.
- Review home sale timing and IRC §121 planning.
- Confirm whether a QDRO is required and plan rollover/withholding decisions before distributions.
- Update withholding/estimated taxes and cash-flow assumptions.
- Update estate documents, account titles, and beneficiary designations.
This blog focuses primarily on the federal tax consequences. You should also consider any community property or marital property tax rules on your situation. Please contact your Wegner Tax Advisor for assistance in minimizing your tax burden pre- and post-divorce.
