Divorce Settlement Taxes: Alimony, Child Support, and Property

Divorce settlement taxes catch people off guard because the biggest surprises aren’t due the year of the divorce. Most transfers between spouses are tax-free at the moment they happen, but retirement withdrawals, future sales of transferred assets, the sale of the marital home, and alimony under older agreements each carry tax consequences that can cost thousands if you don’t plan for them. What follows is a plain walkthrough of which pieces of a settlement the IRS taxes, which it doesn’t, and where the hidden costs sit.

Dividing Property Is Tax-Free, But the Bill Comes Later

When you split assets as part of a divorce, the transfer itself is almost never a taxable event. Under Section 1041 of the Internal Revenue Code, property passing between spouses or former spouses “incident to divorce” is treated like a gift for tax purposes, so neither spouse owes income tax when the asset changes hands.¹ This covers brokerage accounts, rental property, business interests, and essentially any other asset. A transfer qualifies as “incident to divorce” if it happens within a year after the marriage ends, or later if made under a divorce or separation agreement.²

The catch is basis. The spouse who receives the asset takes on the original owner’s tax basis, not its current market value.¹ Say your ex bought stock for $20,000 and it’s worth $120,000 when you receive it. You inherit the $20,000 basis. When you sell, you owe capital gains tax on the full $100,000 of appreciation, including all the growth that happened while your ex owned it.

This matters during negotiations. An asset worth $120,000 with a $20,000 basis is not equal to $120,000 in a bank account. Compare settlement assets on an after-tax basis, not at face value, or you’ll walk away with a split that looks even on paper and isn’t.

Alimony: The 2019 Cutoff Decides Everything

Whether spousal support is taxable depends entirely on when your divorce or separation agreement was finalized.

Agreements Finalized Before 2019

For agreements executed on or before December 31, 2018, the old rules apply: the paying spouse deducts the payments and the receiving spouse reports them as taxable income.³ Only cash payments qualify, and the obligation cannot continue after the recipient’s death.⁴ If you modify a pre-2019 agreement and the modification expressly adopts the new rules, the agreement switches over.

Agreements Finalized After 2018

The Tax Cuts and Jobs Act permanently changed the rules for agreements executed after December 31, 2018. The payer gets no deduction. The recipient reports nothing.⁵ Alimony now moves like child support from a tax perspective: after-tax dollars with no tax consequence on either side. Because the tax burden shifted from the recipient (often in a lower bracket) to the payer (often in a higher one), the change tends to shrink what payers are willing to offer during negotiations.

Child Support Is Never Taxable

Child support is not deductible by the parent paying it and not taxable income to the parent receiving it.⁶ Leave it off your gross income entirely.

Splitting Retirement Accounts Without Triggering Tax

Retirement accounts are the most tax-sensitive piece of a settlement, and the rules split by account type.

401(k)s, Pensions, and Other Employer Plans

To divide an employer-sponsored plan without taxes, you need a Qualified Domestic Relations Order, usually called a QDRO. This is a court order directing the plan administrator to pay a portion of the participant’s benefits to the former spouse.⁷ Without one, the plan is legally barred from paying anyone other than the participant, no matter what the divorce decree says.⁸

The transfer itself is tax-free. Here’s the useful part: distributions taken directly from the employer plan by the alternate payee under a QDRO are exempt from the 10% early withdrawal penalty, even if the recipient is under 59½.⁹ That exception only applies to money taken from the employer plan. Roll the funds into your own IRA first and then withdraw, and the standard early withdrawal penalty applies. The distributions themselves are still taxed as ordinary income regardless of age.

IRAs

IRAs are simpler to divide and don’t require a QDRO. Section 408(d)(6) allows a tax-free transfer between spouses or former spouses as long as it’s made under a divorce or separation instrument.¹⁰ A direct trustee-to-trustee transfer is safest. If you take possession of the funds instead, you have 60 days to deposit them into your own IRA or the IRS treats it as a taxable distribution.

The important difference from employer plans: withdrawals from an IRA received through a divorce transfer are subject to the standard 10% early withdrawal penalty if you’re under 59½. The QDRO penalty exception doesn’t apply to IRAs.⁹ Other IRA exceptions (disability, first home purchase, higher education) may still apply, but divorce itself is not one of them. If you need cash from retirement savings during a divorce and you’re under 59½, pulling from the 401(k) before it rolls over avoids the penalty; pulling from an IRA afterward does not.

Selling the Marital Home

Section 121 shields a substantial amount of profit from the sale of a primary residence. A single filer can exclude up to $250,000 of capital gain. Married couples filing jointly can exclude up to $500,000.¹¹ You must have owned and lived in the home as your primary residence for at least two of the five years before the sale.¹²

Divorce often leaves one spouse in the home and one spouse out, and the law accounts for that. If you receive ownership from your spouse in the divorce, you can count your ex’s period of ownership toward the two-year requirement. And if your former spouse continues living in the home under the divorce agreement, you’re treated as using the home as your primary residence during that time even though you’ve moved out.¹¹ The spouse who leaves can still qualify for the $250,000 exclusion when the house is eventually sold.

If you keep the home, your basis is the original purchase price, not the home’s value at the time of divorce. That number will matter years from now when you sell.

Your Filing Status and Who Claims the Children

Your filing status for the whole year is set by your marital status on December 31. If your divorce is final by that date, the IRS treats you as unmarried for the entire year. If you’re still legally married on December 31, you must file as married filing jointly or married filing separately, no matter how long you’ve been separated.⁴

Head of Household

Head of household status gives you lower tax rates and a higher standard deduction than filing single or married filing separately. You qualify if you’re unmarried (or “considered unmarried”) on December 31, paid more than half the cost of keeping up your home for the year, and had a qualifying person (usually your child) living with you for more than half the year.⁴

Even if the divorce isn’t final, you can be “considered unmarried” for head of household purposes if your spouse didn’t live in your home during the last six months of the year, you paid more than half the home’s upkeep, and your child lived with you more than half the year.⁴

Who Claims the Children

Only one parent can claim a child in any tax year. By default, the custodial parent (the one the child lived with for more of the year) gets the claim. If the custodial parent wants to let the noncustodial parent claim the child tax credit, they have to sign IRS Form 8332 releasing that specific claim.¹³ A clause in the divorce decree is not a substitute for the form.

Form 8332 only transfers the child tax credit, the additional child tax credit, and the credit for other dependents. It does not transfer the earned income credit, the child and dependent care credit, or head of household filing status, which all stay with the custodial parent.¹³ When both parents try to claim the same child, the IRS notices, and this is one of the most common post-divorce audit triggers.

Joint Returns You Signed During the Marriage

Joint tax returns create joint and several liability. Both spouses are on the hook for the full tax, interest, and penalties owed on those returns. That liability survives the divorce, and a decree saying your ex is responsible for the taxes does not bind the IRS. If your former spouse underreported income or claimed bad deductions on a joint return you signed, the IRS can collect the whole amount from you.

Section 6015 provides three forms of relief:

Innocent spouse relief, when your spouse caused the understatement through unreported income or improper deductions and you had no knowledge or reason to know about it when you signed.¹⁴
Separation of liability, available if you’re divorced, legally separated, or haven’t lived with your former spouse for at least 12 months, which lets the IRS allocate the tax deficiency between you so you only owe the portion tied to your own income and deductions.¹⁴
Equitable relief, a catch-all when you don’t fit either of the above but holding you responsible would be unfair.¹⁴

You request any of these by filing IRS Form 8857, generally within two years after the IRS begins collection against you. If you have concerns about returns filed during the marriage, raise them with a tax professional before the first collection notice arrives, not after.

1
Office of the Law Revision Counsel. 26 U.S. Code 1041 – Transfers of Property Between Spouses or Incident to Divorce
2
GovInfo. Treasury Regulation 1.1041-1T – Transfers of Property Between Spouses or Incident to Divorce
3
Internal Revenue Service. Topic No. 452, Alimony and Separate Maintenance
4
Internal Revenue Service. Publication 504, Divorced or Separated Individuals
5
Internal Revenue Service. Divorce or Separation May Have an Effect on Taxes
6
Internal Revenue Service. Alimony, Child Support, Court Awards, and Damages – FAQs
7
Internal Revenue Service. Retirement Topics – QDRO: Qualified Domestic Relations Order
8
U.S. Department of Labor. Qualified Domestic Relations Orders Under ERISA – A Practical Guide to Dividing Retirement Benefits
9
Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
10
Office of the Law Revision Counsel. 26 U.S. Code 408 – Individual Retirement Accounts
11
Office of the Law Revision Counsel. 26 U.S. Code 121 – Exclusion of Gain From Sale of Principal Residence
12
Internal Revenue Service. Topic No. 701, Sale of Your Home
13
Internal Revenue Service. Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent
14
Office of the Law Revision Counsel. 26 U.S. Code 6015 – Relief From Joint and Several Liability on Joint Return