One of the most pressing questions during a divorce is how it will impact taxes. This becomes especially complex when the divorce process spans multiple tax years, creating situations where couples are separated but still technically married for tax purposes.
The IRS follows a simple rule: marital status is determined as of December 31st. A couple who files for divorce in February but doesn't finalize until the following January remains married for that entire tax year. Conversely, a divorce finalized on December 30th means both parties are considered unmarried for the full year. This timing can significantly impact tax liability and filing strategies.
Understanding your filing status options
For couples separated but not yet divorced, tax filing status becomes a strategic decision with meaningful financial implications. Three options typically exist:
Married filing jointly often produces the lowest combined tax bill due to wider tax brackets and higher standard deductions. However, this option carries risk. Both spouses share joint and several liability for the entire tax bill. If one spouse underpays or commits tax fraud, the other remains fully liable. This filing status only makes sense when both parties can be trusted to pay their share and aren't hiding income or inflating deductions.
Married filing separately eliminates the joint liability risk but typically results in higher taxes. The tax brackets are narrower, certain deductions phase out more quickly, and valuable credits like the Earned Income Tax Credit become unavailable. Additionally, if one spouse itemizes deductions, the other must also itemize rather than claiming the standard deduction, which can lead to a much higher tax bill. You also cannot contribute to a Roth IRA using this filing status once you’re income exceeds $10,000.
Head of household status offers a middle ground for separated couples who meet specific requirements. To qualify, spouses must have lived apart for at least the last six months of the year, paid more than half the cost of maintaining a home, and had a qualifying dependent (typically a child) live with them for more than half the year. This status provides more favorable tax brackets than married filing separately while avoiding joint liability concerns.
Community property state complications
Couples in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, plus Alaska if elected) face additional complexity when filing separately. These states generally require each spouse to report half of the community income and claim half of the community deductions, regardless of who actually earned the income or paid the expenses.
This creates planning opportunities for couples in non-community property states. The spouse making the mortgage payment, for example, can claim the full mortgage interest deduction when filing separately, although that may force the other spouse to have a higher tax bill if they don’t have many itemized deductions to claim. Understanding these rules becomes critical when comparing the actual tax impact of different filing strategies.
The alimony deduction changed dramatically in 2019
Anyone navigating divorce needs to understand how alimony (also called spousal support or maintenance) is treated for tax purposes, and this treatment depends entirely on when the divorce agreement was finalized.
For divorces finalized before January 1, 2019: The traditional rules still apply. Alimony payments are tax-deductible for the payer and must be reported as taxable income by the recipient. This created a tax arbitrage opportunity when the paying spouse was in a higher tax bracket than the receiving spouse, reducing the couple's combined tax burden.
For divorces finalized on or after January 1, 2019: If you’re just beginning the process of divorce, then the new law applies, where the Tax Cuts and Jobs Act eliminated the alimony deduction entirely. Payers cannot deduct alimony payments, and recipients don't report them as income. This change fundamentally altered divorce negotiations, as the tax benefit that previously helped fund higher alimony payments disappeared.
Modifications to existing pre-2019 agreements generally maintain the old rules unless the modification specifically elects to apply the new treatment. This distinction affects settlement calculations and requires careful consideration during negotiations.
Child support remains tax-neutral regardless of when the divorce occurred. Payers cannot deduct it, and recipients don't report it as income.
Dependency exemptions and tax credits
Divorce agreements should clearly specify which parent claims the children as dependents each year. By default, the custodial parent (the one with whom the child lives for more than half the year) claims the dependency exemption and related tax benefits including the Child Tax Credit. However, parents can agree to different arrangements, with the custodial parent signing Form 8332 to release the exemption to the non-custodial parent. Oftentimes when there are multiple children, we’ll see each parent claiming a child to maintain equality, but the ages of the children will matter here too.
This decision carries more weight than many realize. The parent claiming the child may qualify for additional benefits including the Child and Dependent Care Credit (for childcare expenses) and education credits. These benefits can be worth thousands of dollars annually and should be carefully negotiated based on each parent's income and tax situation, along with the child’s age and education plans.
Adjusting withholding and estimated taxes
Once divorced, updating paycheck withholding becomes essential, so you’ll want to reach out to payroll if you’re still working to file a new W-4. Single filers typically need more withheld than married filers to avoid underpayment penalties. The IRS Tax Withholding Estimator provides personalized guidance based on individual circumstances.
For those receiving significant non-wage income (including pre-2019 alimony), quarterly estimated tax payments may be required. The IRS expects payment throughout the year, not just at filing time. Missing estimated payments can trigger underpayment penalties even if the full amount is paid by April 15th.
Property division considerations
While property transfers between spouses incident to divorce are generally tax-free, the long-term tax implications matter. The spouse receiving an asset also receives its tax basis, meaning they inherit any embedded capital gains. A retirement account worth $100,000 and a brokerage account worth $100,000 are not economically equivalent if the brokerage account has a $20,000 unrealized gain.
Dividing retirement accounts requires a Qualified Domestic Relations Order (QDRO) to avoid taxes and penalties on the transfer. Without proper documentation, these transfers can trigger immediate taxation and early withdrawal penalties, so consider working with a professional to split these accounts up. Don’t procrastinate this either, as it could impact what you actually receive if the market shifts significantly.
Tax considerations shouldn't drive divorce negotiations, but understanding the implications helps ensure equitable settlements. For personalized guidance on how divorce will affect your specific tax situation, contact us to discuss your circumstances.