You are negotiating the division of assets and believe that two assets with the same value are equal. However, taxes in a divorce in Hinsdale change what you actually receive.
For example, keeping the retirement account while your former spouse keeps the cash may seem fair. Even so, that decision could cost you thousands of dollars later.
The solution is to compare each asset based on its after-tax value. That way, the agreement you sign today reflects what will actually reach your pocket tomorrow.
In this guide, the team at KHK Family Law & Divorce Attorneys explains how taxes in a divorce in Hinsdale and throughout Illinois work, asset by asset.
Why Taxes in a Divorce in Hinsdale Matter So Much
The larger the marital estate, the greater the impact taxes have on the final outcome. Ignoring them can turn an agreement that appears fair into one that is clearly unequal.
The Difference Between Value and After-Tax Value
Imagine a retirement account and a bank account, each worth $200,000. On paper, both are worth exactly the same, but the difference in what you actually keep can be significant.
The money in the bank account has already been taxed, so you can spend the full amount. By contrast, every dollar you withdraw from a 401(k) is taxed before it reaches you.
As a result, that $200,000 in the 401(k) may end up being worth considerably less. That is why a good agreement always compares assets based on their net value.
Transfers Between Spouses During Divorce
Generally, transferring assets from one spouse to the other because of a divorce does not trigger taxes at that time. Federal rules governing transfers between spouses establish this treatment.
However, the tax does not disappear; it is only deferred. The person who receives the asset also inherits its original cost basis and therefore pays the taxes when the asset is sold later.
For example, stock purchased for $10,000 that is now worth $100,000 carries a taxable gain of $90,000. The IRS Publication 504 explains these rules.
How Taxes in a Divorce in Hinsdale Affect Common Assets
Each type of asset follows different tax rules. Therefore, it is important to review the most common assets one by one before negotiating a high-asset divorce.
Investments and Capital Gains
A capital gain is the profit you make when you sell an investment for more than you paid for it. The original purchase price is called the “basis” or original cost.
For that reason, two portfolios with the same current value can carry very different tax liabilities. The portfolio purchased years ago at a lower price will have a much larger taxable gain.
Before accepting an investment portfolio, ask for the original cost of each investment. With that information, your accountant can calculate how much you would owe in capital gains taxes in a divorce.
Retirement Accounts
Money in a 401(k), pension, or traditional IRA has not been taxed. In fact, future withdrawals are generally taxed according to the applicable tax rate. These are the key rules:
- 401(k)s and pensions are divided through a special order called a QDRO.
- IRAs are transferred through the divorce agreement without triggering taxes at that time.
- A 401(k) withdrawal made under a QDRO avoids the early withdrawal penalty.
- Roth accounts, by contrast, are generally withdrawn tax-free if they meet the applicable requirements.
Therefore, an improperly structured transfer can turn the division into a taxable withdrawal with penalties. To understand the process, review our article about QDROs.
The Family Home
When a primary residence is sold, federal law allows part of the gain to be excluded from taxes in a divorce in Hinsdale. To qualify, the owner must meet certain use and ownership requirements:
- Have owned the home for at least two of the past five years.
- Have lived in it as a primary residence for at least two of those five years.
- Exclude up to $250,000 of gain when filing alone.
- Exclude up to $500,000 when the couple still files jointly.
As a result, selling the home before the divorce and filing jointly can protect a larger amount of the gain. By contrast, a spouse who keeps the home and sells it after the divorce generally has a $250,000 exclusion.
Stock Options and RSUs
RSUs are taxed as wages when they vest. Many stock options, on the other hand, are taxed when they are exercised, meaning when the employee purchases the shares.
In addition, when one spouse receives options from a former spouse, that spouse generally pays the taxes when exercising them. Therefore, the agreement should clearly establish who is responsible for each tax obligation.
Business Interests
When one spouse buys the other spouse’s interest in a business, the tax consequences depend on how the transaction is structured. That detail can change the outcome by thousands of dollars:
- If the company buys the spouse’s interest, the tax treatment differs from a personal purchase.
- Equipment and real estate that have already been depreciated can generate additional taxes when sold.
- Accumulated gains within the business can create tax obligations when distributed.
- Installment payments can spread the tax burden over several years.
A business valuation should account for these hidden tax liabilities. Otherwise, the spouse who keeps the business may end up paying for a value they will never receive in full.
Maintenance, Child Support, and Taxes
Support payments also have their own tax rules, which changed several years ago. Therefore, it is important to carefully review the date of your divorce agreement.
Maintenance After the 2018 Federal Change
Maintenance is the support one spouse pays to the other after divorce. A federal law enacted in 2017 changed the tax treatment for agreements signed in 2019 and later.
Since then, the spouse who pays maintenance cannot deduct it, and the spouse who receives it does not report it as income. As a result, maintenance payments are not taxable to the recipient under federal law.
However, agreements signed before 2019 generally remain subject to the previous rules. Therefore, modifying an older agreement requires reviewing how the tax treatment would change for both spouses.
Child Support Is Not Taxable
Child support follows a simpler rule. The parent who pays it cannot deduct it from their taxes, and the parent who receives it does not report it as income.
In other words, the IRS does not treat that money as income or a deductible expense. Therefore, its amount is calculated without considering tax deductions or tax benefits for either parent.
Even so, it is important to clearly distinguish in the agreement which payments are child support and which are maintenance. Confusing language can create problems with the IRS.
Who Claims the Children as Dependents
Claiming a child as a dependent can provide valuable tax benefits. Generally, the IRS gives that right to the parent with whom the child lives for the greater number of nights.
However, that parent can sometimes transfer the right to the other parent through an IRS Form 8332. These are some of the benefits most often discussed during negotiations:
- The Child Tax Credit, which directly reduces the amount of tax owed.
- Head of household filing status, which generally has lower tax rates than filing as single.
- Tax credits for child care expenses.
- Tax benefits related to college education expenses.
It is therefore worth addressing this issue in the agreement, using real numbers. This allows both parents to make better use of available tax benefits and avoid disputes each year.
How to File Taxes in a Divorce in Hinsdale
For the IRS, your marital status depends on your situation on December 31. If the divorce is final before that date, you do not file a joint return. Before making a decision, review these options:
- File jointly if you are still legally married at the end of the year.
- File married separately to limit certain liabilities.
- File as single or head of household if the divorce is already final.
- Request innocent spouse relief for certain tax debts caused by the other spouse.
In addition, joint tax returns from previous years make both spouses responsible for any tax debt. The agreement should state who will pay those debts if they arise.
Finally, keep copies of all tax returns from the years you were married. These records protect your position if the IRS reviews a year before the divorce.
The Role of a Tax Advisor in Your Divorce
A divorce agreement does not truly end when it is signed, but when the first tax return is filed. At KHK Family Law & Divorce Attorneys, we recommend working with an accountant:
- Calculate the after-tax value of each asset.
- Identify hidden taxes in investments, businesses, and property.
- Compare division scenarios before you sign.
- Guide you on how to file taxes for the year of the divorce.
Their work complements the attorney’s role; it does not replace it. While the attorney negotiates and protects your rights, the accountant translates each proposal into clear numbers.
Together, they help prevent you from signing an agreement that looks fair on paper but leaves you with far less money than you expected to receive in the end.
FAQ
Do I Pay Taxes on Assets I Receive in a Divorce?
Generally, not when you receive them. Transfers between spouses because of a divorce are not taxed at that moment under federal IRS rules.
However, the tax may come later when you sell the asset or withdraw the money. That is why it is important to know the original cost basis of each asset before accepting it.
Is Spousal Support Taxable in Illinois?
It depends on the date of the agreement. For agreements signed in 2019 or later, the spouse who pays maintenance cannot deduct it, and the spouse who receives it does not report it as federal income.
By contrast, agreements signed before 2019 generally remain subject to the previous rules: the paying spouse deducts the maintenance, while the receiving spouse pays taxes on it as income.
Who Pays the Capital Gains Taxes if We Sell the House After the Divorce?
Generally, each owner pays taxes on their share of the gain. Therefore, the agreement should clarify how the sale proceeds will be divided and who is responsible for each tax obligation.
In addition, each former spouse generally applies their own exclusion of up to $250,000 if they meet the ownership and use requirements. By contrast, a married couple filing jointly can qualify for an exclusion of up to $500,000.
Should We File Jointly in the Year of the Divorce?
Only if you are still legally married on December 31 of that year. If the divorce is finalized before then, each person generally files as single or, if eligible, as head of household.
Even so, filing jointly is not always the best choice because both spouses can be responsible for errors or tax debts. Filing separately, by contrast, can limit that shared risk.
Should I Keep the House or the Retirement Account?
It depends on your goals and cash flow. The house offers stability, but it also comes with mortgage payments, property taxes, insurance, and maintenance costs each month.
The best decision comes from comparing both assets after taxes and considering your actual budget. An accountant and your attorney can help you make the right choice.
Contact KHK Family Law & Divorce Attorneys
A divorce agreement is only fair if it remains fair after taxes. That is why it is important to carefully review every asset before signing any proposed division.
At KHK Family Law & Divorce Attorneys, we analyze taxes in a divorce in Hinsdale and work with trusted accountants to protect your assets.
Schedule a consultation with KHK Family Law & Divorce Attorneys today. We will negotiate an agreement that protects your assets today and tomorrow, after taxes.
