Divorce After 50: The Tax Mistake That Costs Women Six Figures

Two columns that count different dollars

Settlements are often negotiated on a spreadsheet with two columns whose totals match. The problem is that the columns are rarely counting the same kind of dollar.

A dollar in a 401(k) has never been taxed and will be taxed as ordinary income when it comes out. A dollar in a savings account is already taxed. A dollar of home equity may be partly or wholly excluded from tax. Depending on the bracket, a $400,000 retirement account might be worth closer to $300,000 once tax is paid. An even split before tax can be a substantially uneven split after it.

Retirement accounts: the order that matters

A 401(k) or pension is split by a qualified domestic relations order, or QDRO, a court order that lets the plan pay the other spouse without tax at the time of the transfer.

That order also creates a narrow opportunity. Cash paid directly from the plan to the receiving spouse under a QDRO avoids the 10 percent early-withdrawal penalty, even below age 59 and a half. Income tax is still due, but the penalty exception exists only at that point. If the whole amount is first rolled into an IRA, it is lost. Anyone likely to need cash in the first year after a divorce should decide before the transfer.

An IRA is split differently: through the decree and a direct trustee-to-trustee transfer, not a QDRO. A check written from one spouse’s IRA to the other is a taxable withdrawal for the account owner.

The house and the business

The capital gains exclusion on a main home drops from $500,000 to $250,000 once a person files alone, and the house moves between spouses with its original cost attached, so the spouse who keeps it keeps the gain.

A business raises different questions. Its value is a matter of judgment rather than a price, and an interest in a closely held company is not equivalent to cash. Both subjects have their own episodes on this site.

The date on the decree

Filing status for the entire year is set by marital status on 31 December. A divorce final on 30 December means filing as single for that year. Final on 2 January, the couple was married for the whole of the year before. Close to year end, that single date can move the tax bill by thousands, and it is one of the few things in a divorce that is both consequential and controllable.

The returns you already signed

A joint return makes each spouse responsible for all of the tax on it, not half. A divorce decree assigning a tax debt to one spouse binds the two spouses, but not the IRS. Where there are concerns about returns filed during the marriage, relief exists, but it has deadlines and has to be requested. Tiffani Lindstrom, CPA raises this early for exactly that reason.

Alimony and child support

The tax treatment of alimony depends on when the agreement was signed. Under agreements signed after 2018, alimony is neither deductible for the spouse who pays it nor taxable to the spouse who receives it. Under older agreements the previous treatment generally still applies, with alimony taxable to the recipient, unless the agreement is modified in a way that expressly adopts the new rules. Anyone modifying an older agreement should know which treatment the modification will carry. Child support is simpler: it is never taxable to the recipient and never deductible for the payer.

Once it is final

Beneficiary designations on retirement accounts and insurance usually decide who receives them, regardless of the decree, and many still name a former spouse years later. Withholding and estimated tax need resetting for a single return. Wills, powers of attorney and any titles or deeds that carry both names need updating.