Somehow, when California couples are dealing with the emotional and financial turbulence of divorce, they can forget financial details that could come back to haunt them on Tax Day. Along with navigating the challenges of dividing marital property, it is important to be aware of tax implications that will affect different aspects of the divorce, such as investments or IRAs, alimony or child support payments, or property division or transfers.
Overlooking these issues could create complications later, and for couples in Carlsbad heading for divorce, knowing all the legal angles will help to them protect their financial interests at each stage in the process.
Property division in California
California is one of a handful of community property states, meaning that all property that is not separate is marital assets and debt, or community property, and subject to even division between the parties, unless the court determines another solution based on mitigating circumstances. Separate property is generally anything that you owned, earned, or bought before marriage.
When inventorying separate and community property, looking at the date of marriage and a clear separation date are the best ways of determining when earnings, debt payments, or purchases became separate from community property.
Among the many challenging aspects of working out a divorce settlement, 3 of the most important regarding taxes are:
- Property transfers between spouses, which will generally not trigger tax issues, can be costly for the spouse who sells the family home later on when they must pay the taxable portion of capital gains on the sale. By buying the house from the community property, both the selling and purchasing spouse can avoid some tax pitfalls.
- Retirement accounts, which can incur tax penalties. Dividing IRA funds through a direct trustee-to-trustee transfer can work, however, if one spouse does not withdrawal funds early.
- Child support and alimony, which occurs after the marriage is over, is something the couple must discuss beforehand as part of a settlement agreement. Current tax law no longer allows a tax deduction for child support or alimony payments, nor is it taxable income to the receiving spouse.
Post-divorce tax concerns
Once the divorce is final, it is best for both parties to decide who will claim a child as a tax credit to avoid contentious issues later. As it is the first spouse who files who will benefit, this can be a sore spot if the other one should rightfully be claiming the deduction. While claiming head of household has tax advantages, checking your status first can avoid red flags later.