Surprising Divorce Tax Hacks

Tax season brings anxiety for many, but for those navigating divorce, it also presents unique opportunities to protect your financial future. Despite the complexity, understanding a few key tax concepts can literally put thousands of dollars back in your pocket during this challenging life transition.

Tax literacy remains shockingly low among Americans—only 2% demonstrate proficient knowledge according to recent studies. Yet as this episode reveals, even basic tax understanding becomes a powerful tool during divorce negotiations. For example, the difference between filing as "single" versus "head of household" isn't just paperwork; it represents a $7,300 higher standard deduction and access to valuable credits that could significantly reduce your tax burden.

• To learn more on this topic,  click the link below to watch Jacki's webinar on Tax Literacy for Divorce which was recently posted for Phoenix Financial Advocates. 
  • https://www.youtube.com/watch?v=Ez2sTDEihS0
• To schedule an introductory consult (at no charge) with Jacki, click the link below. 
  • https://calendly.com/roessler-jacki/30min?month=2025-03

Visit us at https://www.roesslerdivorce.com/ to learn more about Jacki's practice and to find valuable resources for your case.

Chapters

• 0:00 Introduction to Divorce Rich Podcast
• 1:16 Tax Literacy and Divorce Benefits
• 3:55 Head of Household Filing Status Explained
• 7:40 Child Tax Credits and Negotiation Points
• 11:15 QDRO Tax Hack for Retirement Funds
• 15:28 Asset Transfer Tax Implications

Transcript

Speaker 1: 0:09

Welcome to the Divorce Rich Podcast. I'm your host, jackie Ressler. I've been a certified divorce financial analyst for 28 years, helping clients and their attorneys navigate the often complex and confusing financial issues in divorce. If you're in the process of, or considering, divorce, now is the time for you to take a deep breath and give yourself permission to find clarity on the financial issues you're facing. Rich means many things to many people. I believe the best definition of being rich is someone who has access to many resources. Along with my guests on this podcast, I will be bringing you a wide variety of information so that you can make sound and informed financial decisions for your financial future. Hi and welcome back to the Divorce Rich Podcast. It's getting really nice outside here in Michigan, which also reminds me that tax season is upon us.

Speaker 1: 1:20

Taxes are a topic that a lot of Americans don't like to talk about. If you are getting divorced or have been divorced, there are some really what I would say are exciting no, I'm a dork, but exciting tax hacks available to you. Tax EDU and the Center for Federal Tax Policy conducted a poll to gauge Americans' knowledge of basic tax concepts and opinions of the current tax code. The results indicated that, regardless of educational attainment. More than half of the respondents lacked basic tax literacy. Younger respondents between the ages of 18 and 45 and those with higher household income generally perform better on tax knowledge questions. However, only 2% of those polled exhibited what the poll designers would call proficient tax knowledge. So why does it matter? It matters because if you are getting divorced or you're in the process of divorce, tax literacy some basic tax literacy will help you save money. It will also help you set yourself up better for your financial future, and it's really difficult to make those kinds of decisions if you're negotiating your divorce and you want to bring up some things that might be tax beneficial to you if you don't know the basics. Now again, if you don't know the basics, as I mentioned a minute ago, you are not alone. The vast majority of Americans don't know basic financial tax literacy. So after this episode today, hopefully you will have some information to set you on the road towards tax proficiency.

Speaker 1: 3:07

I want to put a disclaimer in here that I am not a CPA. I am not a tax expert. I don't prepare taxes. I only have tax knowledge based on the divorce work that I've done for so many years. However, for your specific situation. You always want to reach out to a tax specialist, a CPA, someone that can give you solid advice based on your circumstances. Before we dive in, I'm also going to share that. I did a more in-depth webinar on this topic that I'm going to post the link to below, with Phoenix Financial and that has more detailed information and some visual guides to some of the topics that we're talking about. So, if you are interested, I would highly recommend that you take a look at that webinar. So let's dive right in.

Speaker 1: 3:55

Let's talk about who gets to claim head of household. This is a common misconception. There are some rules that the IRS puts in place to decide who gets to claim head of household. In order to be head of household, which is a better tax category than filing as a single filer there are different tax categories. There's married and joint, married and separate. The worst category for most people there is single and head of household, and those are the different categories and they have different brackets associated with those categories.

Speaker 1: 4:33

In order to claim head of household, you have to have a qualifying dependent or a child. In order to be a qualifying dependent, that person needs to be. You need to be the custodial parent of that person, meaning that you have to have at least more than 50% of the overnights with that child. So I'm going to say that again because I think again that is confusing for some people. In order for the IRS to consider you eligible to claim head of household, you have to have more than 50% of the overnights with that child and you need to provide their. You need to provide the funds whether it's through child support or not for their upkeep, things like paying the mortgage, taking care of the house, food, those kinds of items. So if you don't qualify based on that definition, you really don't get to claim head of household. That doesn't stop people from negotiating in their divorce who is going to claim head of household. You might want to take out your divorce decree, if you've been divorced, and take a look and see what it says Again. A lot of divorce decrees that I see trade off the head of household status between the spouses, which really is not the. It doesn't follow along with the IRS rule. So what do you do if your judgment of divorce says that your spouse gets to claim head of household and you think they don't qualify Again, that would be a really good question for a tax specialist or even your divorce attorney. Why do we care? If we want to file as head of household or single.

Speaker 1: 6:10

Well, the category that you file in awards you a specific dollar amount for the standard deduction. That actually is a dollar for dollar reduction of your taxable income. So if you are single in 2024, your standard deduction is $14,600. That would be deducted off of your income before you start having to pay taxes. So let's say that your income is, uh, $104,600. The first $14,600 doesn't count because that is your standard deduction. Now the standard deduction for head of household, I'm sure you could guess, is a lot higher. The standard deduction for head of household is $21,900. That's a big difference. So if you get to claim head of household, the first $21,900 of your income doesn't count for purposes of being taxable income. It gets deducted off of that calculation. So obviously that is desirable to be able to claim it, just for that reason alone. Another important point is that there are differences in the tax brackets based on whether or not you're filing as single or head of household, which just means that you're going to pay a lower amount on income up to a certain level if you're head of household versus single, and so that again is something important to think about. So is it worth arguing over in your divorce settlement? It might be. That might be a place where you want to get some expert help involved in your case.

Speaker 1: 7:51

Another reason that people would like to be able to claim head of household is that claiming head of household allows them to claim the child tax credit. The child tax credit is a refundable credit up to a certain amount In 2024, the amount of the credit that you can get is up to $2,000 per dependent child, and refundable credit means that even if you don't have any earned income or taxable income from a job, you still get that credit money. So currently, again, the maximum that you can get is $2,000 per dependent child and you also. There is a, I believe that the maximum refundable credit portion is $1,700. So not the full amount is fully refundable, meaning you get it back.

Speaker 1: 8:42

So let's say that you don't have any income at all. Your only income is child support, which is non-taxable, and spousal support, which is also non-taxable, and non-earned income, or alimony, same thing. If that's the case, you still get a benefit from claiming head of household because you get to qualify for that child tax credit for your dependency exemption for the child. There is no longer a. There isn't currently, I should say, in our tax code a financial benefit for being able to claim a dependency exemption, like there used to be a dollar figure benefit that's been taken away for now, but again, the benefit for you claiming a child as your dependent and claiming head of household is that you get that child tax credit. Now, at higher income levels, the tax credit is phased out.

Speaker 1: 9:35

This would be important for you to know. If you're negotiating and you're the low-income earner or no-income earner and your former spouse has income over $200,000 and they're single, they might be phased out based on their tax situation of getting anything available for that tax credit. So, again, this is why it's important that you know the questions to ask To me financial literacy, tax literacy. You don't need to have everything in your head, you don't need to memorize everything, but you do need to know what the questions to ask are and the questions that you want to ask your attorney when you're negotiating. Your case is should we talk about whether or not we want to trade off the who gets to claim head of household, which now you know you really are not supposed to do that because the IRS has their own rule for that in terms of what qualifies you. But again, that's so standard in many of the divorce judgments that I see that it's worth a conversation, especially when we talk about you're going to give that away to someone who might not even be able to take advantage of getting that child credit back. It would almost be a better win if let's say that your former spouse is a high wage earner. It would almost be a better win If let's say that your, your former spouse, is a high wage earner. It would almost be a better negotiation point to say I'm going to claim the kids and then we'll split that whatever the child credit is, because you're not entitled to it anyway. That would be what I would call a financial win-win.

Speaker 1: 11:03

Okay, now that we got the exciting stuff out of the way, the next tax hack that I want to talk about is IRS Regulation 72T2C. You don't need to write that down. Are getting a qualified domestic relations order drafted to transfer money in your former spouse's qualified retirement account over to you. So first a few questions answered. What is a qualified retirement account? A qualified account is tax qualified under ERISA, which is a federal tax law and under the IRS tax code is a qualified plan, it has to follow certain rules and limitations. We're looking at company employer sponsored plans, so a 401k, a 403b. The only way to transfer those types of assets, when you get divorced, into your name is with this separate legal document from your judgment of divorce. It's called a Qualified Domestic Relations Order, or a QUADRO Q-D-R-O for short.

Speaker 1: 12:13

Now, normally, if you need cash and a lot of people getting divorced unfortunately need to free up some cash, whether it's to pay legal bills, put a down payment on a new piece of property or even just do some updates around their house they want to get some cash out. And if the only assets that they have are illiquid, meaning that there's some barrier to getting them, so the barrier could be that you have to pay taxes. In the case of a retirement plan, like an IRA account or a qualified plan, you're going to have to pay taxes in order to get at those dollars. So and that's true even when you get divorced However, when you get divorced, there is a one-time window, an exception, where you don't have to pay the 10% penalty that usually applies on early withdrawals from a qualified plan. So let me give you an example of that. You still pay ordinary income taxes.

Speaker 1: 13:11

So let's go with the example of let's say we've got Mike and Mary. So Mike has $100,000 in his 401k. $50,000 of it is being transferred to Mary with a quadro. Mary decides that she wants to take the entire $50,000 out in cash Another episode. We can talk about whether or not that's a great idea and how to weigh the pros and cons of that. But let's say that she needs to pay off credit card bills and she needs that money. So she takes the $50,000 in cash. There's going to be an automatic withholding of 20% in federal taxes that the plan custodian is going to withhold on that distribution and they're going to send her the rest, so the net cash to her. Let's say, when she actually files her taxes it's going to be not exactly 20%, it depends on what her tax bracket is, but let's say it's 25%. So Kathy would net Kathy, not Kathy, sorry Mary would net $37,500 in after-tax dollars. Now she doesn't pay the 10% penalty that she would normally pay because she's not 59 and a half years old. If Mary is 51 and she took money out of an IRA account, she's going to pay ordinary income tax and she's going to pay the 10% penalty. However, with this one-time quadro exception, she can take whatever amount she wants out of a qualified plan through a quadro only and she can avoid that 10% penalty. Well, that's a nice little divorce hack and again, this can be a tool used even while you're in the process of divorce if you need to free up cash. It's not the greatest tool because it does take some time for a quadro to be drafted and get approved and actually get the money, but it is possible. You don't have to have a final divorce decree in place. You just have to have a case filed in order to have a quadro on any qualified plan, a divorce case filed.

Speaker 1: 15:11

Last but not least, in terms of my fun tax hacks, is that if you got any assets from your spouse pursuant to your divorce decree, that'd be pursuant to a written decree. That is not a taxable event. So let's go back to Mike and Mary, not Kathy. Mike and Mary got divorced in 2024, and Mary received the house. The house had been in both of their names and the house got transferred. The title got transferred into her name alone. That is not a taxable event and she will not owe any taxes on that transfer. And that is true with any asset that gets transferred over to a former spouse, with the exception of series EE or the government savings bonds. Those are the only assets that there might be some tax consequence to transferring between former spouses. But if it's not a treasury bond or a government savings bond, you are not going to be paying any taxes on the transfer. Again, what you do pay taxes on is once you get the asset.

Speaker 1: 16:18

If it's transferred to you in kind meaning that you got, let's say, 50 shares of stock in a brokerage account not an IRA account, but in a brokerage account and you get that stock, the transfer is not taxable. But if you decide that you want to sell it and reposition that money into something else now you're going to potentially be subject to capital gain taxes or a capital loss on that. That would be a taxable event. So if I've got 50 shares of stock and I bought it for $1,000 and I sell it for $10,000, I'm going to pay capital gains tax on the 9,000. Does that mean that the whole 9,000 is the tax? No, I'm going to pay a percentage of that in capital gains tax which is different than and lower than ordinary income tax rates for most people, so, but that is something to be aware of, and that's called the cost basis. Whatever you bought that asset for, the cost basis of the original purchase transfers from spouse one to spouse two if you get that asset. So there isn't any step up or change in the basis when you get divorced. This original basis, whatever you bought that asset for, whether it's a stock or a house, that always remains the same.

Speaker 1: 17:38

Again, if you want to get more in-depth information on this topic, I am going to post a link in the show notes to a webinar that I recently presented on this topic. It's got some visual aids, which are nice. Most important of all, though, is if you have any specific tax questions every person's situation is different. Make sure that you consult with a tax expert for your case. Thanks for listening in. Thanks for listening in. Thank you so much for taking time out of your day to listen to Divorce Rich Podcast. If you like this podcast, please follow us on Apple or anywhere that you download podcasts and share this link with any friends or family that you think might benefit from this information.