Filing taxes can be confusing. Add a separation and impending divorce to the mix, and you may find yourself not only in uncharted territory but also lost at sea. The truth is that separation and taxes can be confusing. However, if you approach the situation systematically, i.e., you look at each area where a separation could impact taxes, paying them while going through a divorce can become less daunting. Here’s how a separation in Alabama could affect how you approach your taxes
Filing Status
One of the first questions that probably comes to mind if you are separated but not yet divorced and are filing your taxes is your filing status at this juncture. As in the rest of the U.S., your filing status in Alabama on December 31 dictates how you file for the preceding year.
Should you finalize your divorce by the end of the year, you can file your taxes as either “single” or a “head of household.” Filing as a head of household does offer certain tax benefits, but to benefit from them, you must meet specific criteria such as paying for more than half of the household expenses and living apart from your spouse for at least six months.
If you are newly separated, filing as a head of household would thus not be available. Your options would, therefore, be to file as “married filing jointly” or “married filing separately. An Alabama divorce lawyer working with a tax professional on your behalf can advise you further about which filing status would apply to your situation.
Alimony and Child Support
In Alabama, alimony can affect one’s taxes. How it does depends on when your divorce was finalized.
Alimony is considered taxable income for the recipient and tax deductible for the payer for divorces finalized before January 1, 2019. However, due to alimony reform, parties paying or receiving alimony as part of divorces finalized after that date are subject to different tax rules; alimony payments are not deductible for the payer or taxable for the recipient.
On the other hand, child support has no tax implications for either party in Alabama and the U.S. It is neither taxable income nor deductible for either party.
Division of Assets
The division of assets in Alabama divorce is yet another area where you could see an impact on your taxes. If you are not cognizant of the potential effects transferring or selling assets can have, you may be in for a few surprises come tax time.
In general, when you transfer property as part of a divorce settlement, it is tax-free. However, you may be subject to capital gains tax if you sell any property as part of your divorce, such as the marital home.
Alabama follows federal tax rules, so you could face capital gains tax if you sell a house for a profit exceeding the exclusion limits ($250,000 for single filers, $500,000 for joint filers). Again, speak with an Alabama divorce attorney and tax professional for advice specific to your case.
Retirement Accounts
It is important to be aware of the effect separating retirement accounts as part of your divorce can have on your taxes. Distributions from qualified retirement plans, including 401(k)s or IRAs, are usually taxable. However, you could face penalties if the transfers are not done correctly.
One purpose of the QDRO is to help you avoid unnecessary penalties and tax consequences in a divorce. Given how confusing a QDRO can be, it is important to consult with an Alabama divorce attorney and tax professional for assistance completing it.
Dependency Exemptions
One of the issues divorcing couples often argue over is who will get to claim the children as dependents on their tax returns. Only one parent can claim a child as a dependent for tax purposes per calendar year, and doing so can lead to tax benefits, including the Child Tax Credit. As a result, some parents choose to alternate years in which they get to claim a child or all the children they share as dependents.
In most cases, the custodial parent — the parent the child lives with most of the year — is entitled to claim the child as a dependent. Based on negotiations, the custodial parent may choose to waive their right and allow their child’s other parent to claim them as a dependent. They can do so by signing IRS Form 8332.
Health Insurance and the Affordable Care Act
If you were covered under your spouse’s employer-provided health insurance while married, coverage could change once you divorce. Should this happen, you may be allowed to participate in COBRA, which allows you to pay to continue your coverage for a specific period. However, due to COBRA’s high cost, you may choose to find new insurance under the Affordable Care Act (ACA).
How you approach healthcare based on your situation could impact your taxes differently. For example, the Premium Tax Credit for Marketplace plans and the self-employed health insurance deduction can reduce taxable income.
If you have employer-sponsored insurance, premiums are typically deducted pre-tax, lowering your taxable income. Also, if you’re eligible, contributing to a Health Savings Account (HSA) can provide additional tax benefits. Although the federal penalty for not having insurance was eliminated in 2018, some states, of which Alabama is not one, still impose penalties. Finally, you may qualify for a medical expense deduction if your total medical costs exceed 7.5% of your adjusted gross income.
Depending on what you negotiate during your divorce, your spouse may be required to pay for your health insurance for a set time. Even so, it can help to think beyond that point and consider, based on the above discussion, how healthcare costs will figure into your post-divorce budget. Consult with an Alabama divorce attorney for further guidance.
Find an Alabama divorce lawyer for advice on how separation can impact your taxes.
Divorce is complicated enough without unexpected tax issues. By understanding how separation and divorce impact your tax situation in Alabama, you can make informed decisions and avoid costly mistakes.
At Summit Family Law, our legal team is experienced in addressing the tax issues arising from separation. We have a network of tax professionals and financial advisors we work with who understand the nuances of Alabama law and can help guide you through the divorce process. With offices in Huntsville and Birmingham to serve you, we are here to help. Call us today or schedule a meeting here.
