What tax issues should you settle in a divorce?

Settle who takes each asset and its tax basis, how support will be taxed, who pays any tax still owed on past joint returns, and who claims the children. Property moved between spouses in a divorce is generally not taxed at transfer, but the receiving spouse inherits the built-in gain. Alimony under agreements signed after 2018 is neither deductible nor taxable.

A settlement that divides assets equally on paper can divide them very unequally after tax. Reviewing the tax side of major life events, including divorce, is part of Kathryn Meyer's strategic tax counsel work, alongside your family law attorney.

How to work through the tax side of a settlement, step by step

1. List every asset with two numbers: its current value and its tax basis. Under IRC 1041 the spouse who receives property takes over the other spouse's basis, so the second number decides what the asset is really worth.
2. Sort the payments. Decide what is alimony, what is child support and what is a property settlement, because each is treated differently for tax.
3. Review every joint return still open. Both spouses remain liable for tax, interest and penalties on joint returns, whatever the decree says, so the agreement should say who pays and who indemnifies whom.
4. Plan the final year's filing status. Whether you are married or unmarried for the whole year depends on your status on December 31.
5. Allocate the children. Decide which parent is the custodial parent for tax purposes and whether a Form 8332 release will be signed.
6. Handle retirement accounts by the right document: a qualified domestic relations order for an employer plan, or a transfer under the decree for an IRA.
7. Divide joint estimated tax payments and any refunds in writing.

The main tax rules in a divorce

Basis: the number that settlement sheets leave out

Section 1041 is a timing rule, not a forgiveness rule. The transfer itself is tax-free, but the spouse who receives an appreciated asset will pay tax on the full built-in gain when it is sold, while the spouse who keeps cash or a high-basis asset will not. Publication 504 also requires the transferring spouse to give the other enough records to determine the adjusted basis and holding period. Ask for those records before signing, not after.

The same thinking applies to a business or a professional practice. An interest in a closely held company can move between spouses without tax under section 1041, but its basis, its payroll and worker classification history, and any planned sale all affect what it is worth. The questions a buyer would ask are set out in the tax questions to settle before selling a business. Lawyers dividing a practice can start with how the sale of a law practice is taxed.

Old joint returns: the liability a decree cannot move

Publication 504 is direct: if you are divorced, you are still jointly and individually responsible for tax, interest and penalties on a joint return for a year that ended before the divorce, "even if your divorce decree states that your former spouse will be responsible." The decree binds the two of you; it does not bind the IRS. An indemnity clause gives you a claim against your former spouse, but the IRS can still collect from you, for as long as the collection period described in how long the IRS has to collect a tax debt remains open.

Relief from the IRS itself comes through IRC 6015, which offers innocent spouse relief, separation of liability for divorced or separated spouses, and equitable relief, all requested on Form 8857. How each works, and the two-year limit after collection begins, is explained in whether you can get innocent spouse relief from tax on a joint return. One protection is automatic: under IRC 6663(c), the civil fraud penalty on a joint return does not apply to a spouse unless part of the underpayment is due to that spouse's own fraud.

What changes the answer

• When the agreement was signed or changed. An agreement executed before 2019 keeps the old alimony treatment unless a later modification expressly adopts the new rule (IRS Topic 452).
• A nonresident alien spouse. The section 1041 nonrecognition rule does not apply if the receiving spouse is a nonresident alien (IRC 1041(d)).
• Transfers in trust. Gain is recognized to the extent the liabilities assumed or attached exceed the property's basis (IRC 1041(e); Pub. 504).
• Community property states. Income and liability rules differ for married people in community property states, including a separate form of relief from liability for community income (Pub. 504).
• Payments that do not qualify as alimony. Noncash property settlements, payments that continue after the recipient's death, and payments made while legally separated spouses share a household are not alimony for federal tax purposes, which matters most under pre-2019 agreements (IRS Topic 452).
• Open audit years. A joint return can be examined for three years, sometimes longer, so the indemnity clause needs to cover the full period described in how far back the IRS can audit.

For example: equal on paper, unequal after tax

For example, imagine a couple in Virginia dividing $600,000 in 2026. He keeps $300,000 in savings. She takes a brokerage account worth $300,000 that they bought for $100,000. Under section 1041, neither pays tax on the transfer, and her basis in the account is $100,000. If she later sells it for $300,000, she reports a $200,000 gain; he has no gain on his cash. Their agreement, signed in 2026, also provides $3,000 a month of spousal support: he cannot deduct it and she does not report it as income. They filed jointly for 2024 and 2025, and the agreement says he will pay any tax later found due on those returns. If the IRS assesses more tax for 2024, it can still collect from her, and her protection is the indemnity and, if she qualifies, innocent spouse relief. Because the final decree is entered in December 2026, each of them files as unmarried for 2026. This is a hypothetical, not a real case.

Common mistakes in divorce settlements

• Trading assets by value alone. Low-basis stock, a rental property with depreciation, or a business interest carries tax that cash does not.
• Relying on the decree against the IRS. Only the IRS can relieve a spouse of joint liability, through IRC 6015.
• Using old alimony assumptions. For agreements executed after 2018, the payer gets no deduction, so support numbers built on a deduction overstate what the payer can afford.
• Attaching the decree instead of Form 8332. For decrees effective after 2008, the noncustodial parent must attach Form 8332 or a similar statement, and the release cannot depend on support being paid.
• Moving retirement money the wrong way. A withdrawal paid to one spouse and then handed to the other is not the same as a transfer under a QDRO or a decree.
• Ignoring estimated payments. Joint estimated payments can be divided any way the spouses agree; without agreement, Publication 504 applies a formula.

What to do this week

1. Make a list of every asset and debt with its value, its tax basis and the records that prove the basis.
2. Pull IRS account transcripts for each joint year to check for balances, notices or open audits.
3. Note the date your agreement will be executed, and whether any earlier agreement exists.
4. Write down the year's joint estimated payments; owners of a firm can review how a law firm owner handles quarterly estimated taxes.
5. Disclose any foreign accounts to your advisers; they carry reporting duties explained in whether you have to report foreign bank accounts.
6. Bring the list to your family law attorney and a tax adviser before the numbers are final.

Frequently asked questions

Can we still file a joint return in the year we divorce?

Not if the final decree is entered by December 31. Publication 504 says you are unmarried for the whole year if you have a final decree of divorce or separate maintenance by the last day of the tax year; if you are only separated, you are married for the whole year.

Is a property settlement paid in installments alimony?

No. IRS Topic 452 says noncash property settlements, whether in a lump sum or installments, are not alimony. Under agreements executed after 2018, the label matters less for income tax because alimony is neither deducted nor taxed.

Who claims the children after a divorce?

Generally the custodial parent, the one the child lived with for more nights during the year. The custodial parent can release the claim with Form 8332, which lets the other parent claim the child tax credit, but the release does not carry head of household status or the earned income credit.

What if the IRS denies my innocent spouse request?

You can ask the Tax Court to review the decision. The steps and deadlines are explained in whether you can take an innocent spouse denial to the Tax Court.

Are my divorce legal fees deductible?

No. Publication 504 says legal fees and court costs for a divorce, including fees for tax advice and fees to obtain alimony, are not deductible. Fees for a property settlement can be added to the basis of the property you receive.

Does the spouse who keeps the house get the full home sale exclusion?

Possibly. Under IRC 121(d)(3), a spouse who received the home from the other spouse counts the other's period of ownership, and a spouse who owns the home is treated as using it while the former spouse lives there under the divorce instrument.

Getting the tax side of a divorce right

Tax questions in a divorce are easiest to settle while the agreement is still being negotiated. Kathryn Meyer spent more than two decades in the IRS Office of Chief Counsel and can review the tax side of a proposed settlement, the exposure on past joint returns and the options if the IRS comes calling. To discuss your situation, contact the firm or call (571) 560-8674.

Sources

• 26 U.S.C. 1041, Transfers of property between spouses or incident to divorce
• IRS Topic No. 452, Alimony and separate maintenance
• IRS Publication 504 (2025), Divorced or Separated Individuals
• 26 U.S.C. 6015, Relief from joint and several liability on joint return
• IRS, Innocent spouse relief
• 26 U.S.C. 6663, Imposition of fraud penalty
• 26 U.S.C. 121, Exclusion of gain from sale of principal residence