Certain tax implications can significantly impact the terms of a divorce agreement, and options should be well thought out. Here’s what you need to know about understanding taxes in an Illinois divorce.
Those who complete their divorce on or before Dec. 31 of the final day of the tax year may not file a joint tax return. If the new year starts before the divorce becomes official, the IRS still recognizes a couple as married, and therefore allows the filing of a joint return for the previous year.
Business Interests and Investments
If either spouse is a business owner, its profits may be taxed as part of personal income. The business or investments may have untaxed losses and gains from the past years that must be carried into the next.
Dependents and Tax Credits
The children’s best interest should be the main priority during a divorce, especially when parental responsibility is being determined. Parents should be aware of how tax implications can affect their children via the exemptions they can claim.
The children will be dependent on the custodial parent. However, exemptions can be split, or the court may order alternative exemptions each year. If the non-custodial parent claims exemptions when it is their turn, the custodial parent must submit a Release of Claim to Exemption for Child by Custodial Parent form with their tax return.
Besides this tax exemption, the parents may also qualify for the following:
Child Tax Credit
Eligible parents can claim upwards of $1,000 as tax credit per dependent child. The children have to be under 17 years old at the end of the filing year.
Child and Dependent Care Tax Credit
If the children are under 13 years of age, they may be claimed on a tax credit for a portion of child care expenses.
Related: Illinois Divorce FAQs
Retirement Account Taxes
In most cases, retirement funds or 401k account transfers are not taxable. Once a divorce is finalized, on the other hand, tax penalties are liabilities that are applicable on payments and withdrawn funds.
To prevent this from happening, make sure retirement accounts are also part of the divorce decree and try not to spend money on divorce expenses. If funds are taken from an investment account prematurely, significant tax implications can be faced. Retirement assets have to be divided as per strict IRS rules and regulations.
When a property is divided as part of a divorce settlement, taxes may not be incurred on it but taxable gains will be considered if the property or investments are sold during the divorce proceedings. The first $250,000 will not be considered and those married during the filing year are legible to up to $500,000 when filing together.
Any funds transferred from a retirement account or pensions will be taxed unless it is transferred into another retirement plan or a Qualified Domestic Relations Order. Any property sold after the divorce is finalized will be eligible for tax gains and each spouse can also exclude $125,000 from taxes.
Spousal and Child Maintenance
Child support is not tax-deductible for the parent responsible for paying it and can not be considered taxable income. However, spousal maintenance can be deducted from the taxable gross income of the payer. Support compromising both child and spousal support is unallocated support which can deduct taxes for the spouse making more contributions than the other.
Determining Filing Status after a Divorce
Taxes should be filed carefully after recently divorcing. Filing statuses depend on certain factors, including the date of divorce and resolution terms. Depending on the circumstances, statuses may be filed under the following:
Married Filing Separately
A tax return can be filed separately even if a couple is still married or as of December 31st. There is a small deduction but owed taxes could be reduced later when filing under this status. As an independent filer, the filer will not be responsible for anyone else.
Married Filing Jointly
Those divorced as of December 31st, cannot file jointly or as married. Filing jointly can feel odd when a couple just divorced but depending on the date of divorce, the filing status for the new year will depend on the marital status. If still married during the specified time, filers can still file jointly and get benefits including the often larger standard deduction offered to married couples.
Those without any children or other dependents should file single. In this case, filers will be eligible for the same deduction as a married person who is filing separately.
Head of Household
If the divorce was finalized before December 31st, filers could still file as the head of the household which awards them a larger tax deduction. One must prove themselves as responsible for paying for more than half of household costs for the past year. A stronger case can be made for those that have a dependent such as a child. However, children can only be claimed as dependent for tax deduction purposes if filers have a majority of parenting time.