Tax Consequences of a Tennessee Divorce

From The Mid-South Divorce Guide, chapter 19, by William W. Jones
IV, a Memphis family law attorney and Rule 31 Listed Family Mediator
licensed in Tennessee and Mississippi. This guide covers Shelby, Tipton
and Fayette Counties in Tennessee and DeSoto, Tate and Tunica Counties
in Mississippi.

Questions this page answers

• Is alimony taxable in Tennessee?
• What is my filing status the year I divorce?
• Who claims the children on taxes after divorce?
• Do I pay taxes on a divorce settlement?

I am not sure I ever took a tax law class in law school. I certainly
tried not to. I made a point of avoiding the entire wing of the building
where they taught it, and I have made peace with that decision.

So I am not your CPA and this chapter does not pretend otherwise. You
should have one, and I will tell you when to call them. But there are
four tax issues in nearly every divorce, and if you do not know they
exist you cannot ask anybody about them.

One. Alimony is not
deductible anymore

This is the biggest change in divorce taxation in decades and it
still catches people out, including people reading older guides.

For any divorce or separation instrument executed after
December 31, 2018, alimony is not deductible by the
person paying it and not included in the income of the
person receiving it. The Tax Cuts and Jobs Act made that
change. The old regime, where the payor deducted and the recipient
reported the income, is gone for new orders.

If you read that anywhere else, in a book, on a website, or from a
well-meaning relative who got divorced in 2004, it is wrong now.

Why it matters. Under the old rules, alimony moved income from a
higher tax bracket to a lower one, which created value out of thin air
and made settlements easier. That is gone. A dollar of alimony now costs
the payor a full after-tax dollar, and negotiations reflect it.

Two exceptions worth knowing. Orders executed on or
before December 31, 2018 are grandfathered and keep the old treatment.
And if a pre-2019 order is modified after 2018, the old treatment
continues to apply unless the modification expressly
states that the new rule applies. That is a drafting decision, and it
needs to be made on purpose. If you are modifying an old alimony order,
raise this with your lawyer and your accountant before anything gets
signed.

Two. Who claims the children

The dependency exemption itself was reduced to zero by the same 2017
law, but the child tax credit and other child-related benefits still
turn on who claims the child, and those are worth real money.

The default under federal law is that the custodial parent claims the
child. Parents can allocate it differently by agreement, and Tennessee
parenting plans commonly do, often alternating years or splitting
children. When the non-custodial parent claims a child, IRS Form 8332 is
generally required, signed by the custodial parent.

Two practical points. Get the allocation into the parenting plan
explicitly, including who signs Form 8332 and by when. And remember that
head of household filing status, the earned income credit, and the child
and dependent care credit have their own rules that do not always follow
the same allocation.

Three. Filing status

Your filing status for a tax year depends on your marital status on
December 31 of that year. Divorced on December 30, you file as single or
head of household for that whole year. Divorced on January 2, you were
married for the entire prior year and you file either jointly or married
filing separately.

This is worth actual money and it is worth talking about with your
accountant, because it can sometimes affect whether it makes sense to
push a final decree across a year boundary in either direction.

If you file jointly, understand that joint returns carry joint
liability. Both of you are on the hook for the whole thing, including
for what the other person did or did not report. If your spouse’s tax
reporting worries you, talk to your lawyer and a CPA about filing
separately and about innocent spouse relief.

Four. Transfers between
spouses

Property transfers between spouses incident to divorce are generally
not taxable events at the time of transfer. But the recipient takes the
transferor’s basis, which means the tax bill rides along with the
asset.

This is why two assets with the same number on the statement can be
worth different amounts. A hundred thousand dollars in a bank account
and a hundred thousand dollars of stock with a twenty thousand dollar
basis are not the same asset. One of them has a capital gains bill
attached.

There are also rules about the capital gains exclusion on the sale of
a primary residence, and the timing of a sale relative to the divorce
can matter.

The one rule

Do not sign a final settlement involving significant assets without
running the tax consequences past a CPA. It is a few hundred dollars
against decisions worth tens of thousands.

I say that as a man who walked the long way around that wing of the
law school for three years.

Download the whole guide. All 35 chapters plus four blank client forms, complimentary, no email required. Download The Mid-South Divorce Guide (PDF)

Questions about your own situation? The Jones Law Firm, 5100 Poplar Ave, Suite 708, Memphis, TN 38137. Call (901) 761-5353.