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What Impact Will Your Divorce Settlement Have on Your Taxes?

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US tax forms
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Question: What Impact Will Your Divorce Settlement Have on Your Taxes?

Answer:

If not addressed properly your final divorce settlement can have costly effects on capital gains and income taxes.

Capital gains taxes and your divorce settlement:

Capital gains refers to the fair market value of an asset minus the cost. For example, if you paid $100,000 for a home and it is now worth $135,000 you will have a capital gain of $35,000. This applies to other assets such as mutual funds, investment funds and any other asset you share that has appreciated in value.

It’s very important that property you receive in your divorce settlement does not have a capital gain larger than your ex spouse. When splitting property don’t be fooled into thinking that property of equal value is to your benefit. You should have the property analyzed to determine the amount of capital gains on the property. This will keep you from ending up with a tax liability come income tax time.

For example, you could be offered an investment account worth $150,000 but the cost basis is only $50,000. That means there is a gain of $100,000 that you must pay at minimum long-term capital gains tax. There could possibly be short-term gains as well, which are taxed at your own marginal tax rate which can be as high as thirty five percent.

In 1997, the federal government eased the income tax burden in regard to your home of residence. You are allowed $250,000 capital gain exclusion per spouse if you have lived in your home for at least 2 of the past 5 years. If the home is to be sold and there is a considerable gain in value (over $250,000), you should consider selling before the divorce to take advantage of the full $500,000 exemption.

Income taxes and your divorce settlement:

Primarily, alimony payments and filing status are affected by your divorce settlement. Alimony received is taxable as ordinary income, so a $60,000 payment received is actually worth $42,000 after taxes when taking into consideration a 30% marginal state and federal tax bracket.

On the flip side, the payer of alimony/spousal support receives a tax deduction. So the same $60,000 payment actually costs the taxpayer $42,000 assuming they are in the same tax bracket.

Filing status is an important decision, you will make after divorce. If you were still married on 12/31 of the tax year, you have the option of filing a joint return with your ex-spouse. If you can do this without conflict, you should consider this option because it can save considerable taxes for both spouses.

If you were divorced after 12/31 and you qualify, filing as head of household versus single can also save tax dollars. You best course of action is to consult a tax professional, before, during and after the divorce process.

 

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