Taxes and Divorce – the basics

1040Dividing Your Marital Estate.

There are no taxes on transfers of property between spouses pursuant to your divorce.  However, any tax basis goes with the asset that is being transferred.  (For example, if you have an investment account which started at $10,000 and is now worth $50,000 through growth, then there would be potential capital gains tax obligation on $40,000.

If you receive a transfer of 401(k) or other ERISA controlled retirement funds via a QDRO, there is no tax on the transfer.  However, if you take out cash from it, then the withdrawal will be taxable (you can avoid the 10% tax penalty if you take the cash directly from the 401(k) after it has been transferred to you via the QDRO, or if you are more than  59 1/2).  If you transfer the funds to your IRA and then take out cash, you will pay income tax plus a 10% penalty for early withdrawal (again, unless you are 59 1/2).

If you receive a transfer of funds from an IRA, and need to take cash out, you will be taxed on the cash withdrawal plus a 10% tax penalty for early withdrawal except under a few exceptions (eg first time home buyer, further education, health-related or economic hardship), or if you are more than 59 1/2 .

Alimony and Child Support.

There is no tax payable on child support received, and the payor does not get an adjustment to income for child support paid.

Alimony is typically taxable to the recipient as taxable income, and an adjustment to income for the payor.

For the recipient of alimony, you either need to pay taxes quarterly on the alimony you are receiving, or have your employer take out more taxes from your paycheck to cover the tax so that you are not penalized at the end of the year for underpayment of estimated tax.

For the payor of alimony, you will probably want to reduce the amount of withholdings the employer is taking from your pay, since you will owe less income tax at the end of the year.

For both of these situations, use the IRS Withholding Calculator to work out how you should change your withholdings.

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