Divorce and Taxes - 10 Things to be Aware of - Part 2

Two things most sane people seek to avoid are divorce and taxes. Unfortunately, when you’re going through a divorce, not paying attention to taxes can cost you thousands. That’s especially true with the tax law changes that went into effect in 2018 and 2019. Now more than ever, not understanding how taxes will affect your divorce can be a very expensive mistake.

Last week we looked at 5 issues to be aware of. This week, we'll look at 5 more.

6. 529 Plans

529 Plans are special tax-advantaged savings accounts that parents (or grandparents) could create to save money for children’s college educational expenses.

In the past, 529 Plans could only be used to fund “Qualified Higher Education Costs.” That’s IRS speak for college/university tuition and certain other college or university expenses.

Under the new tax laws, parents can take up to $10,000 per year out of a child’s 529 Plan and use it to pay for that child’s elementary or secondary school tuition. Now, if your kids are going to private school, you or your spouse could want to use the kids’ college money to pay for it. That will save you from having to pay the private school tuition yourselves.

It will also leave your kids with less money (or no money) to pay for college.

The bottom line is that deciding what to do with your kids’ 529 Plans is now one more thing you’ve got to negotiate in your divorce.

7. Moving Expenses

Before 2018, if you were moving because of a new job, you could deduct your moving expenses from your taxable income. Now, you can’t.

While paying for moving expenses may not be a huge issue in your divorce, the truth is moving costs money. Since there is probably no way you will ever get to deduct those moving expenses from your taxes, you might want to think harder now about how you will pay for those expenses when you divorce.

8. Mortgage Interest & HELOC Payments

The new tax law limits the mortgage interest deduction to interest paid on the first $750,000 of your loan. To be deductible, the loan must also be used to buy, build, or substantially improve the home that secures the loan. That applies to home equity loans and lines of credit, too.

In the past, if a divorcing couple had a home equity line of credit that wasn’t maxed out, they could draw on that loan in their divorce. They could then use that cash to pay for their divorce expenses. Or, they could use it to balance out their property settlement or pay moving expenses.

When they withdrew that money, they could deduct the interest they paid on it from their taxes.

Now, you can still draw on your home equity line of credit in your divorce. But, if you use the money to pay for anything besides home improvements, any interest you have to pay will not be tax-deductible.

9. State & Local Tax Payments

Before 2018, you could deduct the amount you paid in real estate taxes on your federal income taxes. You could also deduct what you paid in state income tax, sales tax and other state and local taxes.

From 2018 on, you can only deduct the first $10,000 you pay in state and local taxes, including income taxes, real estate taxes and sales taxes.

If you’re thinking of keeping your home when you divorce, you’ve got to figure out if you can afford it. Not being able to deduct the full amount of the property taxes you pay can potentially cost you more in income taxes. That increases your expenses and reduces your cash flow.

10. Medical Expenses

Before 2018, you could only deduct medical expenses that exceeded 10% of your adjusted gross income. Now, however, you can deduct medical expenses that exceed 7.5% of your income.

While that 7.5% threshold was supposed to go back up to $10,000 in 2019, it didn’t. So for now at least, you can still deduct medical expenses that exceed 7.5% of your income.

Of course, in order to be to deduct medical expenses at all, you have to be able to itemize your deductions. If you don’t, then you’ll lose this deduction too.

If you have a lot of medical expenses, and you are getting divorced, the lower-income threshold for deducting medical expenses can be good news. First, when you divorce you can no longer file taxes with your spouse. So, you will have less income to declare on your taxes. Since you can deduct expenses that exceed 7.5% of your income, that means you will likely get more deductions.

Divorce and Taxes - Ten Things to be Aware of - Part 1

Two things most sane people seek to avoid are divorce and taxes. Unfortunately, when you’re going through a divorce, not paying attention to taxes can cost you thousands. That’s especially true with the tax law changes that went into effect in 2018 and 2019. Now more than ever, not understanding how taxes will affect your divorce can be a very expensive mistake.

1. Tax Status

The first thing you’ve got to remember about filing taxes after divorce is that your tax status is going to change. Married filing jointly is the most tax-favored way to file taxes. Once you’re divorced, you will lose that status.

Lots of people think that as long as they were married for some part of the year, they can still file taxes as married filing jointly. That’s not true.

Your marital status for income tax purposes is determined as of December 31. If you were married on December 31 you will file your taxes for that year as married. If you were divorced, your only option is to file either as a single person, or head of household.

2. Taxes on Alimony

Historically, alimony (also known as maintenance or spousal support) was tax-deductible to the person who paid it. The person who received alimony was the one who paid the tax on the income.

This was known as the alimony tax deduction, and it often made settling divorce cases easier. That’s because the spouse who received alimony was usually in a lower income tax bracket than the spouse who paid alimony. The alimony tax deduction allowed the couple to shift income from the higher earner to the lower earner. As a result, both spouses paid less in taxes than they otherwise would have paid.

Unfortunately, effective January 1, 2019, Congress eliminated the alimony tax deduction.

Now alimony is no longer tax-deductible to the person who pays it.

That means that if you’re paying alimony to your spouse you have to pay taxes on the income you earn at your income tax rate. Then you have to use your post-tax dollars to pay spousal support to your ex.

3. Personal Exemptions

Before 2018, when you filed your taxes, you got to claim yourself, and each of your kids, as dependents on your taxes. Known as “personal exemptions” or “dependency exemptions,” these tax breaks allowed you to subtract a certain amount of money from your taxable income for every dependent you claimed. The more dependents you claimed, the more money you could subtract.

Unfortunately, from 2018 through 2025, no one gets a tax exemption for claiming the kids as dependents. But then in 2025 (theoretically, at least!) the dependency exemption will spring back to life. Although neither parent will get a tax exemption for claiming the kids as dependents through 2025, theoretically, that will change in 2026 and beyond. So, if your children will still be underage in 2026, you and your soon-to-be-ex still need to decide who gets to claim the dependency exemption for them from 2026 on.

Finally, while the dependency exemption itself may not be worth anything for a few more years, deciding which parent can claim which child as a dependent may affect the child tax credit.

The bottom line is that, divorcing parents still need to decide which parent is entitled to claim which child as a dependent in any given year.

4. Child Tax Credit

Even though the dependency exemption has no value (at least through 2025) unless a parent has the right to claim a child as a dependent, that child might not qualify for the child tax credit on that parent’s income taxes. That’s why, in your divorce, you still need to negotiate which parent can claim each child as a dependent in every year.

If you don’t say who can claim the child as a dependent, you risk losing the child tax credit. The child tax credit directly reduces the amount of income tax you pay. So, it doesn’t just reduce your taxable income. It reduces your taxes.

5. Health Insurance

Not considering how claiming the children on your taxes can impact the health insurance you get for them on the Health Insurance Exchange has become an expensive trap for the unwary.

Most divorcing spouses agree to split the right to claim their children on their taxes in any given year. So either, mom gets to claim the kids in even years and dad gets to claim them in odd years, or mom gets to claim Child A, Dad gets to claim Child B, and they alternate claiming Child C. Doing this is easy and it seems fair enough.

But if dad claims Child B on his income taxes while mom gets health insurance for Child B through the health insurance exchange based on her taxes, mom might end up having to repay the government for that portion of Child B’s health insurance that the government subsidized! The same thing is true if mom claims the kids on her taxes in one year, but dad gets health insurance for the kids through the exchange based on his income.

Who Gets the House in Divorce and What Happens?

You’re getting a divorce and it’s time to figure out major questions like:

• What happens to the house in a divorce?
• Why it’s so difficult to decide what to do with the house in divorce?
• Who gets the house in a divorce?
• Should I keep the house?
• What factors to consider if I want to keep the house?
• Do I have to refinance after divorce?
• What is a divorce house buyout and how does it work?

In this excellent blog posting, Sharon Pastore explores these questions in depth.

Preparing for Divorce: The Top 10 Tips You’ve Got to Know - Part 1

The more you prepare for your divorce, the more you increase your chances of getting the outcome you want. Plus, the more you prepare yourself for your divorce, the more time and money you are likely to save in the divorce process.

Here are 5 of the most important tips you will need to prepare for divorce as effectively as possible. We'll examine 5 more next week.

1. Deal with Your Emotions First. Emotions drive divorce. Period. They drive every argument. They fuel every court battle. And they cause most of the pain.

The more you allow your emotions to run wild, the more likely your divorce will spin out of control.

Of course, controlling your emotions while you’re going through a divorce is no easy task. Divorce is hugely emotional. No matter what you do, you’re going to lose it sometimes.

But, the more you can learn to keep your emotions in check, the less drama you will experience in your divorce.

Because of that, the smartest thing you can do is to start getting a handle on your emotions as soon as divorce becomes a possibility in your life.

Get yourself a therapist or a divorce coach, or join a divorce support group, as soon as possible. Waiting until you have a complete emotional melt-down before you get help is guaranteed to make your divorce more difficult to manage..

2. Get Organized & Collect Documents. Divorce is a document-driven process. You are going to need to put together a small mountain of financial information in order to get through your divorce. (Sorry!)

You’re going to need to gather your income tax returns, W-2 forms, paycheck stubs, bank statements, credit card statements, and tons of other documents.

What’s more, it’s not going to be enough to just dump those documents in a pile on your attorney’s desk. You’ve got to get all your documents organized too.

The more you can organize your financial information for your attorney, the less money you will have to spend to have your attorney organize that information for you.

Of course, when you’re going through a divorce, focusing on anything takes longer. Focusing on organizing financial documents (especially if you weren’t the one who handled the family finances) is even more challenging.

That’s why getting organized in advance is so critically important. The more organized you can be going into your divorce, the more grief you will save yourself during your divorce.

3. Invest in Your Education. The divorce process is not user-friendly. It’s complicated and difficult. It doesn’t work the way most people think that it works.

The more you know about divorce before you start your divorce process, the easier it’s likely to go. But, getting the education you need can be challenging.

First you need to learn about the divorce process itself, as well as the choices you have today for getting through your divorce. Those choices include mediation, litigation, arbitration, and Collaborative Divorce.

Then you’re going to need to learn how you can get yourself ready for whatever process you choose.

You’ll also need to know the basics about how finances work in a divorce. That includes understanding how property is divided in divorce, as well as how child support and spousal support (a/ka/ alimony) are set in your state.

If that sounds like a lot … it is! Thankfully, you don’t need to get everything figured out all at once. You also don’t need to know all the answers BEFORE you start your divorce.

At the same time, while you don’t need to become an expert in everything in order to be prepared for your divorce, knowing as much as you can will help you in a big way.

4. Understand Your Finances If you don’t want to end up behind the financial eight ball after your divorce you must understand how money works BEFORE you start the divorce process.

That means that you need to get comfortable working with numbers. If that thought scares you, it’s time to get over it. (Sorry to be harsh!)

Like it or not, divorce involves money. Not understanding how money works (and not taking the time to learn!) is the single quickest way to get completely screwed over in your divorce.

You can’t divide your assets unless you know what you have and what you owe.

 

You won’t know whether you will be able to survive after your divorce, unless you understand much money you will have coming in after your divorce, and what will be going out.

If dealing with numbers has never been your thing, that’s okay. You don’t need to get a degree in higher math just to make it through your divorce. But you do need to start learning the basics of personal finance asap.

5. Make A Financial Plan

Understanding your finances is step one in preparing for divorce. Having a financial plan for your post-divorce future is step two.

Miss either one of those steps and your post-divorce finances are not likely to be pretty.

A basic financial plan requires you to create two things: A budget, and a balance sheet.

Depending upon how complicated your finances are, you may be able to create both of those documents yourself.

If your finances are complicated, working with a divorce financial planner can be an enormous help. S/he can help you create a basic financial plan. A good financial planner can also help you create financial projections to show you how long your money will last, and how much you need to save to meet your future financial needs.

Many financial planners also work as financial investors. So, after they have helped you create a solid financial plan, they can also help you invest your money so that you achieve your financial goals.