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.

Surviving a Grey Divorce - Part 2

While divorce at any age is difficult, divorcing later in life is qualitatively different than divorcing earlier in life. The reason is simple: finite resources.

When you are older you have a limited amount of time, money, and energy to recoup whatever you lose in your divorce.

When you get divorced in your 50’s, 60's, and beyond, you no longer have decades to rebuild your finances or your life. You may already be retired and your income may be fixed. Or you may have been hoping to retire soon. Either way, your career has likely peaked and your income is probably not going to go up in any serious way.

Last week we looked at 4 critical areas you must understand when you divorce later in life. Here are 4 more.

5. Health Care. The older you get, the more important health insurance and health care in general, becomes. Unfortunately, the older you get the more expensive it is to buy that health insurance!

Unless you are 65 and are covered by Medicare, you need to find some kind of health insurance after divorce that fits into your budget. (Even if you are covered by Medicare, you may need supplemental health insurance as well!)

The mistake many people make is that they don’t investigate their health insurance options until their divorce is almost done. They assume that they can get COBRA coverage at the same price as what their spouse is currently paying for his/her insurance.

When they discover that’s not true, and they find out that their health insurance premiums are going to cost more than their mortgage, their entire divorce settlement gets turned upside down.

What’s even worse is not investigating the cost of health care until AFTER you’re divorced! By that time, the die is cast. You need to find your own health insurans AND you need to apply for it within 60 days after your divorce is final.

That’s why it’s so important if you’re divorcing later in life that you work with a good health insurance broker as soon as possible. That broker can help you find and understand your options …and keep you from tearing your hair out in frustration!

6. Retirement. Getting a divorce after 50 can throw a giant monkey wrench into your retirement plans. Even if you scrimped and scraped so that you had enough money to retire at 60, getting a divorce can change everything.

In the best case, you will only lose half of your retirement accounts. In the worst case, you could lose more.

So the first thing you have to realize if you’re getting a divorce later in life is that you might not be able to retire as soon as you thought you would. Or, you may not be able to retire at all. (Yes. Ouch!)

In order to figure out your retirement options, it helps to work with a GOOD divorce financial planner. S/he can run projections showing you how long your retirement money is likely to last. S/he can also tell you how long you have to work before you can start drawing on your retirement money.

Finally, as with health insurance, it’s important to get complete financial information BEFORE you finalize your divorce. That way you can adjust your negotiations based upon a realistic picture of your financial future.

7. Big Expenses (a/k/a Money Suckers). If you are going to have to live on a budget after your divorce, you need to eliminate as many large, unexpected expenses as you can before your divorce is final.

Sadly, the two things that cause the most large, unexpected expenses tend to be two things people love very much: their house and their adult children. While you can continue to love both after your divorce, you may not be able to continue to support either.

Although most people think of their house as an investment, it is also a liability. Not only do you have to pay the mortgage, taxes, and insurance to keep it, but you also have to pay for maintenance and repairs. All of that can send your budget into a tailspin.

As much as you may love your house, selling it before you’re divorced can may make a lot of financial sense. That way you and your spouse will share any last minute repair costs as well as the closing costs.

Similarly, your post-divorce budget may not have room in it to support your adult kids. Even if you’ve been supporting them for decades, your divorce may force them to finally have to stand on their own two feet.

That’s not necessarily a bad thing. (Although they’re probably not going to like it and may resent you enormously, especially at first!)

8. The Loss of a Lifetime Identity. After you’ve been married for years – or decades – you think of yourself as a married person. You have married friends. You do the things that married people do. Like so many other married people, you dreamed of growing old with someone by your side. … or, at least you had those dreams once upon a time.

When you get divorced, all of that changes.

Your married friends will either take sides or avoid both you AND your spouse like the plague. It almost seems like they’re afraid that your divorce is catching, and that if they continue to spend time with you, they’ll end up divorced too.

Worst of all, for a while (maybe a long while!) you’ll question who you are. You won’t know what you’re “supposed” to do, or how you’re “supposed” to act. You will look back and start questioning your whole life, and everything you thought you knew. Looking forward is no better.

Suddenly, you’re not sure what your future is going to look like anymore. The vision you had for how your life was going to go just evaporated like a puddle on hot cement.

As if all that wasn’t enough, divorce will probably change your status, too.

When you were married, you lived in a certain area. You drove certain cars and had a specific kind of lifestyle.

After your divorce, you may not be able to afford any of that anymore.

Most people’s lifestyle takes a hit when they get divorced – at least for a while.

You may no longer be able to afford the things you had grown accustomed to having. If you still have kids at home, they may not be able to participate in expensive sports or attend private schools. Your adult children may have to learn to stand on their own, without help from mom and dad. Instead of shopping at Whole Foods, you may find yourself in Costco.

All of those things require a profound adjustment. They require you to change your mindset and adjust your identity. While younger divorcing people may have to make those kinds of changes too, it’s still much easier to make those shifts when you’ve only been married for two or three years than it is to make them when you’ve been married for twenty or thirty years.