Tennessee divorce & taxes intersect in numerous ways, affecting filing status, dependent claims, property division, retirement accounts, and spousal support, with significant changes under the Tax Cuts and Jobs Act altering how divorcing couples handle tax returns, tax benefits, and taxable income. From determining whether to file as single or head of household to deciding who claims the child as a dependent and receives the child tax credit or earned income tax credit, divorce is finalized with lasting tax consequences requiring careful planning to maximize tax credits while minimizing capital gains tax obligations on property transfers and retirement account divisions.
How Divorce Changes Your Tax Filing Status
Your marital status on December 31 determines your filing status for the entire tax year, affecting tax benefits and obligations.
In general, your marital status on December 31 of the tax year determines your filing status for that year. If your divorce is finalized by this date, you can no longer file as married filing jointly or married filing separately. Instead, you will need to file as single or head of household, depending on your circumstances.
Filing as head of household may provide certain tax benefits, such as a higher standard deduction and lower tax rates. To qualify for head of household status, you must be unmarried or considered unmarried on the last day of the tax year, pay more than half the cost of maintaining your home for the tax year, and have a qualifying person, such as a child or dependent, living with you for more than half the year.
Tax Implications Under the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act of 2017 fundamentally changed tax law, affecting divorcing couples, particularly regarding alimony and dependent exemptions.
Alimony Tax Treatment After 2018
Under the Tax Cuts and Jobs Act of 2017, alimony payments are no longer deductible by the payer and are not considered taxable income to the recipient for divorce agreements executed or modified after December 31, 2018. This change can significantly impact both parties' tax liabilities and should be considered when negotiating alimony agreements.
For divorces finalized after December 31, 2018, alimony is not deductible for the payer and is not taxable for the recipient. However, for divorce agreements finalized before this date, the old tax structure may still apply, where alimony may be taxable income for the recipient, and the payor may still deduct alimony payments on their federal taxes.
Personal Exemption Changes
There have been many changes to child-related tax benefits, with one of the biggest being the recent suspension of all personal exemptions under the Tax Cuts and Jobs Act. The elimination of personal exemption deductions began with tax year 2018 and remains in effect through December 31, 2025, when the law sunsets.
Claiming Dependents and Child Tax Credits
Divorcing parents must determine who will claim the children as dependents, directly affecting eligibility for valuable tax credits.
Custodial Parent Rights
Generally, the custodial parent, the parent with whom the child lives for more than half the year, claims the child as a dependent. Only one parent may claim a child as a dependent in any given tax year, which can affect eligibility for credits such as the child tax credit or the earned income tax credit.
However, parents can agree to alternate years or allow the noncustodial parent to claim the child if certain conditions are met. It's essential to comprehend that the right to claim a child as a dependent also affects eligibility for various child-related tax credits. The non-custodial parent can claim the child as a dependent under Form 8332 if the custodial parent signs the form releasing the exemption.
Tax Credits Affected by Dependent Claims
Who claims the child as a dependent determines access to several important tax benefits, including the child tax credit, the child and dependent care credit, and the earned income tax credit. These tax credits can make a significant difference for families, especially those with lower incomes, navigating the financial challenges of divorce in Tennessee.
The divorce agreement should specify which spouse will claim each child and under what circumstances, as this decision can impact eligibility for certain tax benefits and deductions. Failing to clarify these details can lead to confusion, disputes, or even IRS audits down the road.
Child Support Tax Treatment
Child support payments have a different tax treatment than alimony under federal tax law.
Child support payments are not deductible by the payer and are not considered taxable income to the recipient. Paying or receiving child support doesn't have tax implications in Tennessee or elsewhere in the United States, as these payments represent support for the child rather than income to either parent.
The general justification for this tax treatment is that child support, as the name implies, is to provide one's child with the support they need. The custodial parent supports the child with their time and resources, while the non-custodial parent offsets the resources it takes to raise a child through financial child support.
Capital Gains Tax on Property Division
Transferring property during divorce in Tennessee can trigger capital gains tax depending on how and when assets are sold.
Property Transfers Between Spouses
U.S. tax code 1041(a) states that a transfer of property incident to divorce does not result in a gain or loss. This means that capital gains tax should not ordinarily be triggered if property is exchanged between partners as part of dividing property in their divorce case, as they are not receiving the benefit of a capital gain.
A transfer of property incident to divorce will likely not be subject to capital gains tax if the transfer took place within one year after the finalized divorce, or within six years of the marriage ending, and was called for under the divorce decree. Transferring certain assets, such as retirement accounts or investment properties, between spouses during divorce typically does not trigger immediate taxes.
Sale of Family Home
When a couple sells the marital home and divides the proceeds, this can trigger capital gains tax on any profit from the sale. If you are selling a family home that was lived in and owned for a long enough period, there is a maximum exclusion of gain of $250,000, or $500,000 if married filing jointly, on capital gains from eligible sales of this type.
The capital gains tax applies to the profit made on the sale of an asset, and is very common when a couple has a large property like a house that they sell because of divorce in Tennessee. When one spouse is awarded the family home and later sells it, any profit from the sale may be subject to capital gains tax depending on how much the home increased in value and how long it was owned and lived in.
Retirement Accounts and Tax Implications
Division of retirement accounts during divorce requires careful handling to avoid unnecessary taxes and penalties.
QDRO Requirements
If you are planning to receive a share of your spouse's retirement funds, the transfer must be handled through a Qualified Domestic Relations Order (QDRO) to avoid early withdrawal penalties or taxes. Dividing retirement accounts may require a QDRO to avoid early withdrawal penalties and taxes when splitting 401(k)s, pensions, or other qualified plans.
Tax Responsibility on Retirement Distributions
Even with a QDRO in place, the receiving spouse will be responsible for taxes once the funds are received. If you have retirement accounts, keep in mind that you would typically only pay taxes on the money you receive; money going to your ex-spouse is that person's income, not yours.
Most retirement accounts of individuals who were divorced have some money paid into them while they were single and some money paid into them while they were married. Once divorced, your spouse will be owed a portion of your retirement payout, assuming you don't have a settlement that states otherwise, and tax obligations follow the distribution accordingly.
Tax Deductions and Divorce Expenses
In general, you cannot deduct legal fees and court costs for getting a divorce. However, you may be able to deduct legal fees paid for tax advice in connection with a divorce and legal fees to get alimony. In addition, you may be able to deduct fees you pay to appraisers, actuaries, and accountants for services in determining your correct tax or in helping to get alimony.
You should request a breakdown showing the amount charged for each service performed. You can claim deductible fees only if you itemize deductions, and they are subject to the 2% of adjusted gross income limit. Fees for tax advice on federal, state, and local taxes of all types, including income, estate, gift, inheritance, and property taxes, may be deductible.
Tennessee State Tax Considerations
Tennessee's state tax structure simplifies some aspects of divorce and taxes for residents.
Tennessee keeps things simple when it comes to state taxes. The state does not tax wages, salaries, or alimony payments, including alimony awards granted by a court order. That means residents don't have to report alimony or alimony awards as income on a Tennessee state return, regardless of whether payments are made voluntarily or enforced by court order.
Federal law does all the heavy lifting when determining tax treatment of divorce-related payments. Whether alimony is taxable depends almost entirely on the federal rules tied to your divorce date and the provisions of the Tax Cuts and Jobs Act.
Working with Tax Professionals
Navigating the tax implications of divorce in Tennessee requires coordination between legal and tax advisors.
It is important to always consult with your CPA or tax professional when addressing tax issues in a divorce. The details matter, and qualified tax professionals can help ensure proper reporting and maximize available tax benefits while minimizing tax liabilities for both spouses.
You should work with a knowledgeable attorney and tax professional to ensure that assets are divided in a tax-efficient manner and that filing status, dependent claims, and all other tax aspects of your divorce are handled correctly. Trying to sort out tax law and divorce agreements without expert help often leads to confusion and costly mistakes.
IRS Resources for Divorced Individuals
The Internal Revenue Service provides helpful publications explaining the tax treatment of divorce-related issues.
IRS Publication 504 titled "Divorced or Separated Individual" contains comprehensive information, including the special rule for children of divorced or separated parents and detailed explanations of tax treatment for alimony, property transfers, and filing status determinations. This publication is available as a PDF online and offers easy explanations of complex tax rules.
IRS Publication 971 addresses "Innocent Spouse Relief" for situations where one spouse should not be held responsible for tax liabilities arising from the other spouse's actions. These resources help divorcing individuals comprehend their tax obligations and rights under federal tax law.
From tax returns preparation reflecting accurate filing status to maximizing tax benefits through proper dependent claims while minimizing tax law violations, divorce is finalized with lasting implications requiring coordination between family law attorneys and tax professionals to protect the custodial parent's access to tax credits, ensure proper reporting of taxable income, and structure property divisions and retirement accounts transfers to avoid unnecessary capital gains tax and early withdrawal penalties affecting both spouses' financial futures.