How to Avoid Tax Trouble During Divorce

Board Certified Family Law Specialist Matt Arnold answers the question: “What happens when a person’s income is not guaranteed and fluctuates from year to year”.


When you are dealing with a divorce, it can be hard to feel like you are ever fully prepared. Given the complexities of the divorce process and the emotional issues involved, few people can honestly say they’re equipped to face every challenge that comes along. That is why it is so easy for things to fall through the cracks, especially issues that you did not even know to look out for. One example of an important problem to be aware of concerns tax trouble related to the divorce. To learn more about how to avoid creating tax issues for yourself, keep reading.


Calculator-and-papers-Charlotte-Divorce-Mooresville-Family-Law-Attorney-300x225First, why is this even a concern? Though you may not realize it, divorce is an area of law that routinely touches on tax issues. Decisions made during and after a divorce can have significant tax implications and should be carefully thought through. The problem is that most people don’t even realize the tax consequences of their actions until it’s too late. To help with that, be sure and consider the following tips.


First, ensure that you use QDROs to divide any qualifying plans or retirement accounts, like a 401(k). QDROs (Qualified Domestic Relations Orders) exist to help you divide retirement plans in the most tax beneficial way possible. QDROs are used to create a right by your spouse to receive a certain percentage of the balance of the account. This is critical because it is also allows your spouse to access his or her share of the money and roll it over tax-free into another qualified retirement plan. This allows you to divide money easily and without losing a bundle due to taxes.


Second, be careful when transferring money between IRAs. The good news is you won’t need to use a QDRO to get this done, but you’ll still need to be careful. If you set up an IRA in your spouse’s name, you should be able to do a tax-free transfer of money from your existing IRA. The key here is that the tax-free deal only works if your divorce decree requires that you transfer the IRA money to your spouse. If the divorce decree doesn’t and you access the money anyway, you’re looking at potentially sizable fees.


What fees are we talking about? With the IRA, if you fail to handle the transfer properly you’ll usually owe a 10% penalty tax on the money that was improperly accessed. With a 401(k), the payment can be substantially higher. Not only will you have to contend with a 10% penalty fee, you’ll also be forced to pay taxes on the money as if it’s part of your taxable income. Depending on the amount of money withdrawn, it could even push you into a higher income tax bracket.


Another tax issue that you need to watch out for both during and after the divorce concerns the child tax credit. Some couples assume that so long as they both have visitation with the children they should both be allowed to receive the child tax credit. That is, unfortunately, incorrect. The general rule is that whichever parent is the primary custodial parent in the settlement agreement is the one entitled to claim the tax credit. If the settlement agreement isn’t clear, it goes to the parent who lived with the child the most during the previous year. All that said, this issue can be negotiated separately during a divorce if you think ahead. It may be that one parent would benefit more than another by getting the tax credit (usually the parent with the higher income) so even if that parent isn’t the primary custodian, it can be agreed that he or she gets to claim the tax credit. This is a good example of how a little bit of advanced planning can end up saving you a lot of money down the road.


If you find yourself facing a complicated family law matter, then you need the help of experienced family-law attorneys in Charlotte, North Carolina who can help guide you through the often confusing process of divorce. Please contact Arnold & Smith, PLLC today at (704) 370-2828 or find additional resources here.


About the Author

ARNOLD & SMITH LAWMatthew Arnold is a Managing Member of Arnold & Smith, PLLC, where he focuses on the areas of family law, divorce, child custody, child support, alimony and equitable distribution.

Mr. Arnold was raised in Charlotte, where he graduated from Providence Senior High School. He attended Belmont Abbey College, where he graduated cum laude, before attending law school at the University of North Carolina at Chapel Hill on a full academic scholarship.

A certified Family-Law Specialist, Mr. Arnold is admitted to practice in all state and administrative courts in North Carolina, before the United States District Court for the Western District of North Carolina, and before the Fourth Circuit Court of Appeals in Richmond, Virginia.

In his free time, Mr. Arnold enjoys golfing and spending time with his wife and three children.





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