Are there divorce issues related to California taxes?

On Behalf of | Apr 24, 2023 | Divorce |

During the divorce process, there are a lot of considerations. Though, what you may not think about are the tax implications. This is especially true in a state like California that has community property laws.

In this blog post, we will describe some of the common California and federal tax issues that may arise due to a divorce.

Marital asset and debt division

One of the main tax issues that divorcing spouses need to consider is how to divide their marital assets and debts. Depending on the type and value of the assets, such as real estate, retirement accounts, stock options or business interests, there may be capital gains or losses, depreciation recapture or early withdrawal penalties that affect the tax liability of each spouse.

Additionally, some assets may have a different basis for federal and state tax purposes, which can result in different tax consequences. For example, California does not conform to the federal exclusion of gain from the sale of a principal residence for divorced or separated spouses who do not meet the joint ownership and use tests.

How to file

Another tax issue that may arise due to a divorce is how to file tax returns for the year of separation or divorce. Generally, spouses can choose to file jointly or separately, depending on their marital status as of December 31 of the tax year.

However, each filing status may have advantages or disadvantages, depending on each spouse’s income, deductions, credits and liabilities.

For example, filing jointly may result in lower tax rates and higher standard deductions, but it also exposes both spouses to joint and several liability for any tax deficiencies or penalties.

Filing separately may limit the liability of each spouse, but it also disallows certain deductions and credits, such as the child and dependent care credit, the earned income credit and the education credits.

Child-related tax benefits

A third tax issue that may arise due to a divorce is how to allocate the dependency exemptions and child-related tax benefits for any minor children. Generally, the custodial parent (the parent who has physical custody of the child for more than half of the year) is entitled to claim the dependency exemption and the child tax credit for the child.

Form 8332 (or another similar statement) can be used to give this exemption to the other parent.

The noncustodial parent can then claim the dependency exemption and the child tax credit for the child, but not the other child-related tax benefits. These include the head of household filing status, child and dependent care credit and the earned income credit. These benefits remain with the custodial parent unless otherwise agreed.