Legal Consequences of Divorce

Effect of Divorce on Taxes & Insurance

When a divorce is finalized, there are many different legal implications for federal and state taxes, as well as for insurance designations. In terms of your taxes, it is important to understand that your tax filing status will change, and that you may need to pay additional taxes depending upon matters in your divorce such as property distribution or alimony. If you have minor children from your marriage, the amount of time you spend with your child according to physical custody or parenting time laws can also affect certain credits or exemptions that you are able to claim on your income taxes. Beyond your tax situation, divorce also results in significant changes to insurance designations and beneficiaries. Your spouse cannot remain insured under any health insurance policies through your employer or vice versa. In addition, you will likely need to change your insurance beneficiaries once the divorce is finalized, yet some parties with minor children or disabled dependents will view beneficiary designations differently.

It is important to speak with a divorce lawyer and financial advisor who can provide you with information about your tax situation after divorce and details about your insurance. In the meantime, the following information can provide you with general information about the effect of divorces on taxes and insurance.

Tax Filing Status After Divorce

Once a divorce is finalized, the parties will need to change their tax filing status in the upcoming year. Your filing status will be “single” during the entire year in which your divorce is finalized. Accordingly, whether your divorce has been finalized by December 31 will determine your filing status for that year. For example, whether a married couple’s divorce is finalized on February 1, 2019 or December 31, 2019, federal tax law will consider each of them to be “single” for the entire 2019 tax year. If a married couple sees certain benefits to filing jointly while the divorce process is ongoing, the parties should speak with an attorney about timing the final divorce judgment appropriately. For instance, it may be possible to time the divorce judgment for early January 2020 instead of December 2019, resulting in the couple being eligible to file their taxes jointly for the 2019 tax year.

Alimony, Spousal Support, and Spousal Maintenance Taxes

Until recently, the spouse receiving alimony (also known as spousal support or spousal maintenance) would be responsible for paying taxes on alimony received as if it were income. In that formulation, the spouse paying alimony would be able to deduct the alimony from taxable income. The Tax Cuts and Jobs Act (TCJA) changes how alimony is now taxed for any divorces finalized after 2019. To be clear, divorces finalized with alimony in 2019 or early use the old system. Any divorce finalized after 2019, however, will see alimony taxed differently. Under the new system, the spouse paying alimony will also pay income taxes on that amount, while the spouse receiving alimony will not be required to pay taxes on that money.

Minor Children and Tax Deductions and Credits

Spouses with minor children would not have needed to determine which of them was eligible to claim certain child-related tax deductions or credits during the marriage. However, once the divorce is finalized, federal tax law does not permit both parents to claim the same child-related tax deductions or credits. Under the TCJA, child tax credits and other taxation matters involving minor children have shifted.

The Child Tax Credit (CTC) allows one parent a tax credit of up to $2,000 for a qualifying child who is 16 years old or younger. The TCJA doubled the CTC from $1,000 to $2,000. In order to be eligible, your modified adjusted gross income must be under $200,000 if you are not married filing jointly, or $400,000 for married filing jointly. A parent can be eligible to receive the CTC if they provided at least 50 percent of the child’s support during the previous year, and if the child lived with the parent for at least 50 percent of the year. For parents with shared custody or parenting time, the parents will need to agree about which of them will claim the CTC. At the same time, given the income requirements, getting divorced may result in one parent’s ineligibility for the CTC. For example, if one of the parents earns $75,000 per year and the other parent earns $300,000, they could have claimed the CTC married filing jointly. However, under the TCJA, the parent earning $300,000 filing “single” after the divorce would be ineligible.

The Child and Dependent Care Tax Credit is also available, and can provide anywhere from 20 percent to 35 percent of up to $3,000 on child care costs depending on the parent’s income. The child must be 12 years old or younger, the parent claiming the credit must have earned income, and the care provider cannot be a parent or other dependent.

Transferred Property and Taxes

When property is divided in a divorce, one or both of the parties could owe taxes on certain transferred property. While most property will not result in additional income tax, if any property is transferred to a trust, or if retirement benefits are transferred to an account that is not a retirement account, the spouse may owe additional taxes on the amount.

Life Insurance Beneficiaries

Once a divorce is finalized, it is important to revisit insurance beneficiaries. Most married people name their spouse as the beneficiary on policies. Unless the spouse who holds the policy changes the beneficiary, then the ex-spouse will still receive the proceeds from the policy upon the insured’s death. In order to avoid an ex-spouse receiving benefits from a life insurance policy (or another insurance policy), the insured must change the designated beneficiary. You should also know that you may be able to name contingent beneficiaries, as an article in The Balance discusses.

However, there are some situations in which the insured may want to keep the ex-spouse as the beneficiary on the policy. For example, if the couple has minor children from the marriage, then the parties may have an agreement that the ex-spouse will remain the beneficiary until the children reach the age of majority. If the insured is concerned that the ex-spouse will not use the money for their minor children, the insured can establish a trust, and proceeds from the life insurance policy can go into the trust. The insured should name a trustee other than the ex-spouse to administer the trust.

Health Insurance and Ex-Spouses

It is also important to understand that most health insurance policies will not allow an insured to keep an ex-spouse as an additional insured on a health insurance plan. For example, if Spouse #1 has a health insurance policy through her employer and Spouse #2 has health insurance on that policy, once the divorce is finalized, Spouse #2 will need to find different health insurance.

To learn more about the effect of divorce on taxes and insurance, you should speak with an experienced financial advisor or a divorce lawyer in your state.





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