Taxes & Divorce

Understanding QDROs

A Qualified Domestic Relations Order (QDRO) is a court order that grants a portion of a retirement plan participant's benefits to an alternate payee, typically a former spouse, child, or other dependent. Developing a QDRO involves several crucial steps, starting with an agreement of the parties or a final decree of the court requiring the division of a certain asset, such as a retirement plan or 401(k). The process requires precise legal documentation and careful scrutiny to ensure that the division of retirement benefits is executed according to the plan's rules and federal regulations, safeguarding the rights and interests of both the plan participant and the alternate payee.

Components of a typical QDRO include:

• Participant and Alternate Payee Information: Details about the retirement plan participant (the individual whose benefits are being divided) and the alternate payee (the individual receiving a portion of the benefits), including full names, addresses, and Social Security numbers.
• Name and Address of the Retirement Plan: Identifying the specific retirement plan from which the benefits are being divided.
• Amount or Percentage of the Participant’s Benefits: A clear statement specifying the portion of the participant's benefits to be paid to the alternate payee, which can be expressed as a fixed amount or a percentage.
• Payment Duration and Commencement: Terms dictating the duration for which the payments will be made (e.g., until the alternate payee's death or remarriage) and the starting date of these payments.
• Method of Payment Calculation: Instructions on how the payment amounts will be calculated, which may vary depending on the type of retirement plan.
• Tax Treatment: Guidelines on how the payments will be taxed to the alternate payee.
• Rights of the Alternate Payee: Specifications on the alternate payee’s rights under the plan, including participation in any plan benefits or options, as well as details on how their interests are protected if the plan participant attempts to make changes to the retirement plan.
• Death of the Participant: Provisions in the event of the participant's death, including whether the alternate payee will continue to receive benefits and if so, in what form.

What Is the Impact of QDROs on Retirement Plan Participants?

The impact of QDROs on a participant's retirement plan can be substantial and varies between the short-term and long-term. In the short term, the division of assets through a QDRO immediately reduces the total value of the participant's retirement plan account, affecting their current savings trajectory and potentially altering their retirement planning strategy. It's crucial for participants to reassess their retirement goals and savings plans to accommodate this decrease in assets.

In the long term, the effect of a QDRO can extend beyond the immediate financial implications. Participants may need to increase their retirement contributions to compensate for the divided assets or potentially delay their retirement to ensure their savings are sufficient to meet their future needs. This could impact the investment strategy of the remaining retirement plan funds, necessitating a reassessment of risk tolerance and investment goals to ensure they align with the participant's retirement timeline and financial objectives.

Tax implications stemming from QDROs are pivotal for both parties involved to understand. The individual receiving the retirement plan assets (the alternate payee) is generally responsible for taxes on the distributions, which can be significant depending on the amount received and their tax bracket. However, if the distribution from the QDRO is rolled over into another qualified retirement account, such as an IRA, taxes can be deferred until the funds are withdrawn, potentially allowing for tax-efficient growth.

For the original plan participant, the distribution made under a QDRO is not considered a taxable event, offering a unique exception to the typical early withdrawal penalty. This means that while the participant’s immediate retirement plan value decreases, the distribution doesn't increase their taxable income for the year, providing a silver lining in the process of asset division.

Ways to Protect Your Retirement Assets

Protecting retirement assets in the face of a QDRO involves strategic planning and action both before and during divorce. One proactive approach is the prenuptial or postnuptial agreement, specifying the division of retirement assets in the event of a divorce, thus providing clarity and potentially mitigating disputes.

Another critical step is maintaining open communication with legal and financial advisors to ensure that the QDRO terms do not unfavorably impact one's retirement plans more than necessary. It’s essential for the plan participant to review and understand their retirement plan’s specific rules and regulations, as these can significantly influence the outcome of the QDRO. Additionally, considering alternatives such as offering other assets in place of retirement funds, when possible, can help preserve the retirement account's integrity.

Lastly, after the QDRO is finalized, it’s pivotal to reassess and adjust the retirement savings plan, potentially increasing contributions or revising investment strategies to ensure long-term financial stability and goal achievement.

If you are looking for legal guidance during your divorce proceedings, turn to our team at The Law Offices of Daniel J. Miller. Our attorneys have experience in negotiating QDROs and can provide tailored representation for your family law needs. Call our firm today at (757) 267-4949 to learn more.

Divorce is difficult even under the best circumstances, and there are plenty of life adjustments to be made. From finding new living arrangements to figuring out a new schedule for your children, there are many things to consider after a divorce. Amidst all of this, you probably aren’t thinking about how filing taxes will be different after the divorce, but it’s certainly something you should consider.

Declaring a New Tax Status

Once your divorce is finalized, your tax status will likely change. You may have been filing as “married filing jointly” previously but now need to change it to “single” or “head of household” in the next tax year. When doing this, you need to keep in mind that your filing status will be determined by the date your divorce was finalized. If it’s finalized after the last day of the tax year, you may need to file jointly or file your own as “married filing separately.”

The Benefits of Filing Jointly While Separated

If you’re going through a period of separation from your spouse, you may be wondering what this means for your taxes or how you should file them. You may think the obvious choice is to file separately since you’re going through a period of separation, but you may be hurting yourself if you do this. There are pros and cons to each, but if you are amicable with your spouse and can file jointly, it can make things much fairer for everyone involved.

If you choose to file jointly, you will be able to take advantage of many of the same tax credits and deductions that you would have had throughout your marriage. Everything should stay the same as it was before you were separated, so it should be fairly straightforward to file your taxes and know what you’re getting back. If you file separately, the amount may be notably different than it would be if you file jointly.

Additionally, filing jointly can be extremely beneficial for both parties if children are involved. If you’re filing separately, only one parent can claim the child for a tax credit. This means that the other parent won’t be able to claim the child on their tax returns and won’t be eligible for the child tax credit. This can make a big difference in the amount you receive in your tax return and could be incredibly unfair to the parent who does not receive the tax credit.

Not every separated couple is on good enough terms to file jointly, though, and that’s understandable. There are also benefits to filing separately, such as keeping your tax liabilities separate. You have to figure out what will work best for your scenario to know how you should file your taxes.

Child Tax Credits

Additionally, you will also have to figure out who will receive the child tax credits. If one parent has sole custody over the child, it’s likely that they would receive this credit, but there are certain circumstances and situations that allow for the noncustodial parent to claim it. Some couples even choose to alternate who uses it each year.

Property & Business Ventures

There are a few other situations to be aware of if you’re going through a divorce. If property is being transferred between spouses or ex-spouses, it is a nontaxable event. Likewise, if the couple owns a business together and one spouse buys out the other or they continue to co-own the business, it is a nontaxable event. But if the business is sold to a third party, it could end up being a taxable event. Furthermore, alimony payments are also no longer taxable as of 2017.

When to Involve a Divorce Lawyer

Divorce is difficult enough as it is— you don’t want to add issues with the IRS to your struggles. If you’re unsure where to turn or what steps you need to take in your divorce, the Law Offices of Daniel J. Miller can help.

Whether your divorce is complicated or simple, you will benefit from having one of our experienced family law attorneys on your side. If you’re in need of representation, give our office a call today at (757) 267-4949 or contact us online.

Did you receive a letter from the Internal Revenue Service this January? One of those ominous-looking letters that makes you more than a little nervous about what’s inside? Then, when you opened the letter did you find out the IRS was actually asking for more money? If that happened to you, you aren’t alone. A lot of people are being informed they need to pay back their child tax credit in 2022.

How did this happen? To understand that let’s briefly look what the child tax credit is, how it was recently modified and how that modification might be causing you a financial headache today.

The Child Tax Credit

The Federal Child Tax Credit was passed by Congress in 1997 and signed into law by President Bill Clinton. The legislation implemented refundable tax credits based on the number of dependent children a person claimed on their income tax return. The size of the tax credit depended on the person’s income and filing status (single, married, etc.) and over the years grew as high as $2,000.

An important distinction in tax terms must be made–a credit is not the same as a deduction. A deduction reduces the overall income that is subject to taxation. But a credit is even more valuable–it is a reduction in the actual amount of taxes you owe.

Let’s say you make $85,000 a year. A $2,000 deduction that reduces your taxable income to $83,000 is nice, but it’s not a game-changer. But a tax credit, that takes the final amount of money you owe the IRS and knocks two grand off it? That’s a big deal.

Furthermore, the child tax credit was refundable. That means even if you only owed $1,000 in taxes, you could still get a $2,000 credit and get the difference refunded to you. There was a $1,400 cap on the refundable portion of the credit. That means in our example above, the person would get $400 back from the IRS. As an alternative to paying a thousand, that’s not bad.

It’s not hard to see why the child tax credit is significant. It was money in the pockets of lower-income parents, and for middle-class parents raising three children of their own, it was an economic lifeline.

The American Rescue Plan of 2021

The American Rescue Plan–known more casually as the most recent installment of the COVID-19 relief packages that have passed the Congress, made an expansion of the child tax credit. It was upped as high as $3,600, depending on the income and filing status of the person, along with the age of the children.

There was also one other big change the American Rescue Plan made to the child tax credit. The 2021 legislation paid the credit in advance. People got the refundable part of their credit before filing their taxes.

It’s this latter fact that brings us to your ominous-looking letter of January 2022.

How would the IRS know how much your credit be? How would they know what portion of that credit was refundable? The answer is that they looked at your 2020 tax returns and based the size of their checks on that information. It all seems fine up to now. But what happened if there was some significant life change that impacted what your 2021 tax returns actually look like?

Income Changes Lead to Overpayment

Was your income down in 2020? That was certainly the case for a lot of people in the year the pandemic hit the U.S. economy the hardest. Unless your job was classified as “essential”, you were at risk of being laid off. If you worked in sales, generating commissions was tough sledding.

The child tax credit works on a sliding scale, so those who earn less money can get a higher credit. Now, what if your job returned to normal in 2021? Or maybe you got a promotion. Anything that resulted in you earning more money in 2021 means the size of your child tax credit could have been reduced.

But under the terms of the 2021 legislation, the advance payment of your refundable tax credit was based on your 2020 income. Under previous tax law, the size of your income and tax credit would have just risen and fallen together. The terms of the American Rescue Plan created a disjointed relationship between income tax return and the payment of tax credit. You got more money in 2021 than you otherwise would have.

The professed goal of the legislation was to get money into people’s hands quickly post-pandemic and stimulate an American recovery. The flip side of  is that now the bill is due. That bill is the letter you got in January.

Divorce Impacts Child Tax Credit Payments

Another way the overpayment of tax credits might have happened is with a divorce and change in child custody. Only one parent can claim children as dependents for income tax purposes. If you were still married in 2020, the kids would have been your dependents and you got the tax credit. Let’s say that you go through a divorce which gets finalized in January 2021, and your spouse has primary custody.

You are not likely the one getting the child tax credit in these circumstances, but under the terms of the American Rescue Plan, an advance payment would have been made to you based on 2020 information. Now the IRS wants their money back.

It’s also common for divorced parents with shared custody to essentially “take turns” in using the child tax credit. Maybe 2020 was your year for the credit and 2021 belonged to your ex. I suppose it’s possible the IRS could have figured that out before cutting you a check based on 2020 information…but they didn’t. Now the IRS wants their money back

Paying Back the Refundable Tax Credit

That January letter–Letter 6419 for reference purposes–can be used in filing your returns this spring. The amount of money you were overpaid in 2021 will be applied to either increase your tax payment this year or reduce the size of your refund.

At The Law Offices of Daniel J. Miller, we know how difficult and aggravating it can be to deal with the IRS. We also know how much divorce impacts tax situations. Whatever your legal needs are, from defending yourself in court to negotiating terms in a divorce settlement, don’t hesitate to call us at (757) 267-4949 or contact us online to set up an initial consultation. .