Divorce is a trying time in any woman’s life, and it presents its fair share of changes and challenges. If you’ve recently experienced a divorce, this coming tax season may be yet another hurdle.
As you prepare to file a return post-divorce, review these important tax considerations first. We hope this guide answers some of your most pressing tax questions for 2021. But if you’re still unsure of where to start, don’t hesitate to connect with a tax professional as well.
First, choose the right filing status.
First and foremost, you need to determine what filing status to use this year. This decision will impact your entire tax return, as it dictates your tax bracket, standard deduction, contribution limits, and more.
Let’s start with the timeline of your divorce. If your divorce was finalized by December 31, 2021, you have the option to file as either single or head of household (more on this second option below). So, if you finalized your divorce before the end of the year, you cannot file as married filing jointly or married filing separately on your 2021 tax return.
If you were in the process of getting divorced but didn’t complete it before the end of 2021, the IRS still considers you married for the 2021 tax year. There is a silver lining to this, though, as a married filing status tends to provide more generous tax breaks than filing as single.
When can you file as “head of household?”
Remember, if you’re officially unmarried by the end of 2021, you can file as head of household.
There are three conditions you must meet to qualify for this filing status:
- You were legally considered unmarried by the end of 2021.
- You had a qualifying dependent living with you for more than six months during the year.
- You paid more than half the costs for the upkeep of your home.
If you meet all of these conditions, you may find it beneficial to file as head of household rather than single. Those who file as head of household receive a larger standard deduction ($18,800 versus $12,500), but only one of you can use this filing status.
Don’t forget to update your W-4
While you’re thinking about your taxes, don’t forget to update your W-4 at work. Doing so will ensure your company isn’t withholding the same amount of taxes it was when you were married.
What about kids?
After going through the divorce process, you already know the challenges that arise when children are involved. Unfortunately, managing your tax return with children is another hurdle recently divorced women must conquer.
During the divorce process, one of you was named the custodial parent, indicating who the child spends the most time living with. If you are the custodial parent, lots of tax doors open up to you.
- Claiming the child as a dependent
- Earned income tax credit
- Child tax credit
- Higher education tax credit
- Dependent care credit
- Medical expense deductions (if greater than 7.5% of your AGI)
The non-custodial parent is not eligible to claim these tax deductions and credits. However, the custodial parent can sign Form 8334, which would transfer the rights for the tax advantages to the non-custodial parent.
Alimony & child support
The rules regarding alimony have changed since 2019. If you got divorced before 2019, you could take an above-the-line deduction for any alimony payments. The person who received the alimony would then report the payments as taxable income.
These tax rules have since changed, and divorces finalized after 2019 are not subject to alimony deductions or taxes. Child support operates similarly to recent alimony tax laws, meaning there are no deductions for paying it or taxes on it as income.
Protect your retirement accounts
When you were married, it’s likely your spouse was named a joint owner or beneficiary to specific assets, like retirement accounts. With a divorce finalized, it’s vital to protect these assets.
If you have an ERISA retirement plan, such as a 401(k), 403(b), 457, or pension plan, you will need a qualified domestic relations order or QDRO. This document dictates that, in the case of a divorce, a certain amount of money must be removed from the account and distributed to a spouse. A QDRO also allows you to take distributions from these retirement accounts without incurring a tax penalty if you’re still under the age of 59 and 1/2.
Take note of taxes on asset transfers.
When assets are transferred and distributed between you and your ex-spouse, it’s essential to consider potential tax obligations.
For example, a $50,000 checking account is not the same as company stock options valued at $50,000. If you received those stock options, you wouldn’t pay tax on the transfer. But you would be responsible for paying any applicable taxes if you choose to exercise and sell them These taxes would depend on how much the asset appreciated since it was initially purchased.
Similarly, if 401(k) assets are distributed and not rolled over into a new account, there may be a tax penalty. Even without an additional penalty, these funds may be treated as taxable income depending on the circumstances. If so, they would not be worth the same amount as non-taxable assets since you’d need to consider the income tax.
Work with a tax professional
Wealthcare for Women is here to help you manage all of your financial concerns after experiencing a divorce. We encourage you to seek help from an accountant or CPA this tax season. The first few years following a divorce can have complicated tax repercussions, and a tax expert can help bring you peace of mind.
If you need a referral to a tax professional, we’d be happy to help.