Taxes and Divorce

Understanding the tax code is a full-time job, but it’s imperative that you understand how your divorce decree impacts your tax situation. There are a few main things you should be familiar with as you negotiate.  

Tax Filing Status 

Your tax filing status is dependent on your marital status on December 31st of each year. If you are mid-divorce you will need to file your taxes as Married Filing Jointly or Married Filing Separate. If you finalize your divorce on December 30th you will have to file as either Single or Head of Household.  Each one of these filing statuses comes with its own breakdown of income for each of the tax brackets and some nuanced rules around credits and deductions allowed and to what level. If you are in the process of getting a divorce and there are children involved, make sure you understand the difference between Head of Household and Single filing status. You can speak with a Certified Divorce Financial Analyst® for a high-level overview, but your CPA or accountant can guide you in the specifics. As you change tax filing status’ make sure to adjust the withholdings on your paystub by updating your W-4 so that you are withholding the proper amount for taxes.  

Tax Credits 

There are a few important tax credits to highlight in divorce, especially for the 2021 tax year. The Child Tax Credit and Child and Dependent Care Credit are two credits that often come up in divorce if children from the marriage are involved. Typically, the primary parent, usually the one claiming Head of Household, would claim both credits if they qualify however the non-custodial parents (or the one that has the child(ren) less time) could negotiate that the child tax credit be transferred or alternate. Why is this valuable? A credit is a dollar-for-dollar reduction in your tax bill. The maximum child tax credit is $2,000 per child up to certain income limits. In 2021, thanks to the American Rescue Plan passed by the Biden Administration in early 2021, there is an additional $1,000 per child ages 6-17 and an additional $1,600 per child ages 0-5. The 2021 additional credits are limited to lower tax brackets than the standard child tax credit, and your tax filing status matters in determining what that threshold is. This could be quite substantial! Be aware that these additional tax credits are also getting partially paid out in the second half of 2021. They are not stimulus payments so you need to understand how you will file for 2021 to determine whether you may have to repay those credits. There were also major increases to the Child and Dependent Care Credit, for some, it could be as much as an $8,000 credit! For more information contact your local Certified Divorce Financial Analyst® or CPA to understand how these changes may be impacted by your decree.  

Ordinary Income vs Capital Gains 

When you divide investment assets in lieu of a divorce the transfers themselves don’t normally cause any tax implications, but if you need to begin accessing funds from those assets to live on or make a large purchase then tax implications will come into play. As you negotiate your settlement make sure you are aware of your short- and long-term needs because it may adjust how you should approach the property division. There are two types of tax that could come into play if you sell an asset, the first is capital gains. Currently, most people fall in the 15% capital gains bracket however it can be higher if you are in the top tax brackets. This tax comes into play in the sale of a home or investment property or if you sell from a non-retirement investment account. You pay the tax on the amount of the gain, which is the difference between the value at the time of sale and what you paid for the asset. The second type of tax is ordinary income. Ordinary income is the tax you pay on all income including any distributions from pre-tax retirement accounts, like a 401(k), IRA, or annuity.  

As you can see taxes are complex and have a lot of moving parts. As you negotiate your divorce settlement be sure to understand how your decisions will impact your tax situations now and in the future. For more guidance contact your local Certified Divorce Financial Analyst® and CPA for guidance.  

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Top 3 Financial Tactics to Plan for Your Divorce

Divorce does screwy things to a person’s head. The once intelligent together woman that you were turns into an emotional, brain-fogged, unorganized basket case. I’ve seen it first hand. You try really, really hard to keep it together but you know this will not go down as ‘the best of times.’ You want to sit down and get it together and plan your future but feel paralyzed and surrounded by a pea-soup fog of indecision.   

What’s a person to do? 

Well, first, see your reality and get ready to do something about it.  

ADMIT WHAT YOU DON’T KNOW 

When it comes to the family finances, what’s your role? Do you handle the bill paying? Are you “in the loop” on all your investment accounts, retirement plans, bank accounts, etc. or are you in the dark? If you’re in the dark, you need someone to help you turn the lights on – and fast!  If you and your spouse are cooperative, ask for statements on all your asset accounts and your most recent tax returns so you can find a CDFA® to help you out and bring you up to speed.  If you can’t access information that’s okay a CDFA® can help you think of ways to get some information or we will work to obtain it through Discovery, which is now required in the state of Texas. A CDFA® is specially trained in the financial aspects of divorce and will be your best friend in this process! He/she’ll clear out that brain-fog with determination of those West Texas Winds! 

THINK ABOUT YOUR FUTURE 

This is hard at first, but start thinking about what the next phase of your life looks like. Unfortunately, this has to happen at the same time that you are grieving what you thought the next phase was going to look like. But if you allow yourself some space, it can actually be fun. You now have the chance to start from scratch. What did you used to dream of doing that got lost while you were married? Is it time to go back to school? Maybe a cool downtown loft condo should replace that huge family home that you had to keep clean.  Whatever you dream of, you have to have your budget and financial picture top of mind. So the step above has to come first so your dreams don’t outsize your wallet! 

BUILD YOUR SINGLE FINANCIAL IDENTITY 

Often through marriage all the credit cards, mortgages, loans, etc. are in the names of both spouses. All of those accounts will have to be closed or converted. After the marriage is over, your credit picture may not be nearly as strong, so you want to be sure to put some things in place while you’re still married. Immediately open a checking and savings account in your own name to begin the process of establishing your own financial identity. Next, find a good rewards credit card to apply for in your name alone so that you will be assured of having access to credit post divorce and maybe even during if legal fees are necessary.  

These steps seem small but are valuable first steps to get you thinking financially and looking out for your future. You can get through this but a little help from a CDFA® friend is a great place to start. 

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