Beware The Unintended Tax Ramifications of Your Divorce Settlement

While you may not know it, a divorce can have significant tax ramifications that could land you in serious financial trouble with large amounts of debt to the worst creditor of them all – the IRS. And unlike others you might owe money to, the IRS always gets its money, doesn’t care who it gets it from, and is the only entity on the planet that can find a way to get blood from a stone.

How do divorcing couples land in trouble with the IRS? Often, it’s because they file their taxes as "Married Filing Jointly."

When a couple files their taxes as "Married filing jointly", both people are liable to the IRS for the whole amount. Is your ex a deadbeat who agreed to pay the taxes, and didn’t? The IRS doesn’t care and you’re still on the hook for the original amount, plus penalties and interests. In the worst case, where you can’t pay and/or don’t want to pay, the IRS can garnish your wages, and auction off your property to recover your ex’s unpaid taxes.

You also might see your tax burden suddenly increase because of the divorce. Couples who used to file as "Married Filing Jointly" enjoyed better tax rates. With a divorce, you might find yourself owing more in taxes as you lose the more favorable tax brackets for "Married Filing Jointly." If this is going to be a considerable burden to you, your attorney might suggest filing for a legal separation rather than a divorce, which provides many of the same benefits and clarity that a divorce does, but still allows a couple to reap many of the same financial benefits of a married couple.

Also, the divorce settlement could trigger tax liabilities that you don’t have the money to pay. For example, money pulled out of a restricted account like a pension fund or 401(k) retirement account as part of a settlement would be both taxed and penalized for "early withdrawal." Sales of marital assets during the property settlement, such as a house, could trigger capital gains taxes. But this does not need to be the case. For instance, your divorce settlement need not be structured in a way that requires early withdrawal, but rather postpones the withdrawal until a later date.

Unfortunately, all of these situations occur way too commonly in divorce cases. In order to protect yourself, and avoid and any unexpected debts or taxes, you should consult a divorce attorney who is familiar with tax law and can help you structure your divorce settlement in a way that helps minimize any negative financial ramifications you may experience.

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