Tax Consequences of Divorce Settlements People Overlook

Important note before we begin. I am a matrimonial attorney and mediator, not a tax advisor or CPA. Nothing in this post is tax advice, and nothing here is a substitute for guidance from a qualified tax professional who knows the details of your specific situation. What this post does is flag tax-adjacent issues that come up regularly in divorce settlements — the kinds of issues I make sure show up on a client’s conversation list with their own CPA. Tax law changes; your facts change; what’s right for your neighbor may not be right for you. Talk to a tax professional.

With that said: in my experience, the financial consequences clients regret most after a divorce settlement are not the ones their attorney bargained over. They are the tax consequences nobody flagged in time. The same dollar of value in two different forms — cash, real estate, retirement, an interest in a business — can have very different after-tax outcomes years later. The job of a careful matrimonial process is to make sure those differences are visible before the agreement is signed.

Here are the categories that come up most often, with a note about what to bring to your tax advisor for each.

About the Mediator — A Note from Erin

At Angiuli & Gentile, I have spent 23 years as a matrimonial litigator and 22 years as a divorce mediator. Across two decades of guiding families through divorce settlements, the tax-adjacent issues below are the ones I see overlooked most often — and they are the ones I make sure are surfaced in a careful mediation. I want every mediation I take on to succeed, and part of what makes a mediation succeed is a settlement that holds up over the next five years of tax returns, not just on paper. To get that right, the matrimonial work has to be coordinated with sound tax advice. That is why we partner with tax professionals, not pretend to be them.

Your Filing Status During and After Divorce

Your federal filing status for any given tax year is generally determined by your marital status as of December 31 of that year. That single fact — what your status is on that one date — drives whether you file jointly, separately, as head of household, or as single for the entire year.

What to discuss with your CPA. Whether the timing of finalizing your divorce affects what filing status options you have. In a year when divorce is pending, the choice between filing jointly and filing separately can have meaningful consequences in either direction — joint filing can be more favorable but carries joint responsibility for the tax liability, while separate filing limits that exposure but may also limit certain credits and deductions. There is no universally correct answer; it depends on your numbers.

Alimony / Maintenance and the 2019 Rule Change

This is one of the changes that catches people off guard most often. Under current federal law:

• For divorces or separation agreements finalized on or before December 31, 2018, maintenance (alimony) is generally deductible by the payor and taxable income to the recipient.
• For divorces or separation agreements finalized on or after January 1, 2019, the federal tax treatment flipped: maintenance is generally not deductible to the payor and not taxable income to the recipient.
• Modifications to pre-2019 agreements can sometimes trigger the new rules, sometimes not — the language of the modification matters.

This matters because the negotiation math for maintenance changed dramatically when the deduction went away. A payor under post-2018 rules cannot pass any of the tax burden of those payments to the recipient. Negotiations need to take that into account on both sides.

Note also that New York State has its own treatment of maintenance that does not always mirror the federal rules. This is exactly the kind of issue where a CPA familiar with both federal and New York State income tax is the right person to model the actual after-tax cash flow on each side.

What to discuss with your CPA. What the actual after-tax cost (to the payor) and after-tax benefit (to the recipient) of any proposed maintenance number will look like, under both federal and New York State rules, in the years it will be paid.

Dividing Property: The Cost Basis Trap

Most transfers of property between spouses pursuant to a divorce are not taxable events at the moment of transfer. That sounds straightforward — and it is, for that moment. The trap is the cost basis.

When property passes between spouses in a divorce, the recipient generally takes the property at its original cost basis — not its current fair market value. That means the embedded capital gain (or loss) goes with it. Two assets of equal current value but different cost bases are not really equal. The spouse who takes the asset with the lower basis is taking on the future tax bill embedded in it.

Common example. $200,000 in cash and $200,000 in a brokerage account of long-held stock sound like a 50/50 split. They may not be, once you account for the unrealized capital gains embedded in the stock.

What to discuss with your CPA. The cost basis of every significant asset you are dividing, and what the after-tax value would be if you were to liquidate it. This is the homework that produces a genuinely equal division rather than a cosmetically equal one.

The Marital Home

Real estate has its own set of considerations. Federal tax law generally allows a primary-residence capital gains exclusion — up to $500,000 of gain for married couples filing jointly who meet the ownership and use requirements, and up to $250,000 for a single filer who meets them. There are exceptions and refinements; the application of these rules to a home that is sold during or after a divorce can be more nuanced than people assume.

What to discuss with your CPA. Whether selling the home during the marriage (before the divorce is finalized), at the time of the divorce, or after one spouse has bought the other out produces meaningfully different tax outcomes. The right answer depends on the gain, on each spouse’s filing status going forward, and on timing — all of which the CPA can model.

Retirement Accounts and QDROs

Dividing retirement assets in a divorce is one of the most procedurally specific areas of the settlement. It is also the one where small mistakes are the most expensive.

A Qualified Domestic Relations Order (QDRO) is the legal document that allows certain employer-sponsored retirement plans — 401(k)s, 403(b)s, defined-benefit pensions — to be divided in a divorce without triggering early-withdrawal penalties or treating the transferred amount as taxable income to either spouse. QDROs are technical; they have to be drafted to meet both the plan administrator’s specifications and the requirements of the law. A QDRO drafted incorrectly can delay the division for months or, worse, fail to qualify and trigger tax.

IRAs are treated differently — they are typically divided through a “transfer incident to divorce” rather than a QDRO — but the same theme applies: precise paperwork is what keeps the transfer tax-deferred. Mistakes here can mean a withdrawal that the IRS treats as taxable distribution, with possible penalties.

As co-owner of Northstar QDRO, I am uniquely positioned to assist and guide our clients through the retirement-division stage of their divorce. We work closely with Northstar to draft the appropriate QDROs or DROs, and we also work regularly with other QDRO preparers when a particular case calls for it. Being well-versed in the issues of retirement division is a real benefit for our clients — they do not need to outsource what is often one of the most technical pieces of the settlement.

What to discuss with your CPA. The tax treatment of any retirement money you are receiving or giving up, whether the transferred funds are pre-tax or after-tax (Roth), and what your distribution plans are once the division is complete.

Children: Credits, Dependency, and Head of Household

Federal tax law generally allows only one parent to claim a given child as a dependent in a given tax year. The default rule is that the custodial parent (loosely, the parent the child lives with more than half the year) is the one entitled to claim — though a parent can in some circumstances release the claim to the other parent using IRS Form 8332. Eligibility for various child-related credits and for head-of-household filing status depends on a number of factors beyond just “who has the kids more.”

We routinely include language in mediated agreements about how the parties intend to handle these issues going forward. We don’t, however, tell parents what the right choice is — the answer is fact-specific and depends on each parent’s income, filing situation, and a CPA’s review.

What to discuss with your CPA. What the various child-related tax positions would look like on your return, how an alternating-year arrangement would compare to a fixed arrangement, and how head-of-household eligibility works in your circumstances going forward.

How We Approach Tax Issues in Mediation

In mediation, we do not draft tax advice into your agreement. What we do is flag the tax-adjacent issues as they come up, build in time and structure for you to discuss them with your tax professional, and — when the situation calls for it — bring a neutral tax advisor into the process for both spouses to consult.

The reason this matters is simple. The settlement that looks fair on paper isn’t always the settlement that holds up over the next five years of tax returns. A careful process is one that gets the after-tax picture as right as it can before anyone signs.

Frequently Asked Questions

Do I have to pay tax on what I receive in a divorce settlement?

Whether and when tax applies depends on what you receive. The transfer itself between spouses is generally not a taxable event. The character of the asset — its basis, whether it’s pre-tax retirement, whether it will be sold — drives what happens after. Your CPA can walk you through what to expect on the assets in your specific settlement.

Is alimony / maintenance still deductible?

For federal purposes, it depends on when your divorce or separation agreement was finalized. Pre-2019 agreements generally follow the old rule (deductible / taxable). Agreements finalized on or after January 1, 2019, generally follow the new rule (not deductible / not taxable). Your CPA can confirm how your specific facts apply, and how New York State treats it.

How do we divide retirement accounts without triggering taxes?

Employer-sponsored plans like 401(k)s and pensions generally require a Qualified Domestic Relations Order (QDRO). IRAs are typically divided through a transfer incident to divorce. Both require precise paperwork. We prepare QDROs in-house through Northstar QDRO.

Who claims the children on their taxes after a divorce?

Under federal default rules, the custodial parent typically claims. Either parent can in some circumstances release the claim to the other via IRS Form 8332. The right approach for your family — including how it interacts with credits, deductions, and filing status — should be reviewed with your CPA before your settlement is signed.

What’s the most common tax mistake people make in divorce?

Treating assets as equal by face value without accounting for cost basis or built-in tax. Cash, real estate, retirement, and a brokerage account each carry different tax characteristics. Without that analysis, a “fair” split on the page can be quietly unequal in practice.

If you’re navigating a divorce and want to make sure the tax issues are flagged

We’re matrimonial attorneys and mediators — not your CPA. But part of how we run a careful process is making sure the tax-adjacent issues in your settlement are surfaced, structured, and routed to the right professional before anything is signed. When the situation calls for it, we bring in a tax advisor as a neutral resource for both spouses.

Schedule a low-cost mediation consultation by calling 718-816-0005 or visiting our website at AGLawNYC.com.

Erin K. Colgan, Esq. is a Senior Partner and Mediator at Angiuli & Gentile, LLP, and is a co-owner of Northstar QDRO. She has 23 years of experience in matrimonial litigation and 22 years as a certified divorce mediator. She is Part 146 compliant, a member of the Family & Divorce Mediation Council of Greater New York, and an approved panel mediator with the American Arbitration Association. She is not a tax advisor; this post is for general information and is not tax advice.