Divorce Settlement Taxes: Alimony, Property, and Retirement

Taxes on a divorce settlement depend on what’s being divided and when: most direct transfers between spouses are tax-free at the moment of divorce, but the assets carry hidden tax bills, alimony is taxed differently depending on when your agreement was signed, retirement account splits follow strict rules, and the sale of a family home has its own set of exclusions. Getting any piece wrong can cost thousands.

Property Transfers Between Spouses

Dividing property in a divorce is almost never a taxable event at the time of transfer. 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 applies to brokerage accounts, rental property, business interests, and any other asset.

A transfer counts as “incident to divorce” if it happens within one year after the marriage ends. Transfers made more than a year later still qualify if they occur within six years of the divorce and are made under a divorce or separation agreement.² Transfers after six years are presumed not to be divorce-related.

The Carryover Basis Trap

The tax-free transfer has a catch. The spouse who receives the property also inherits the original owner’s tax basis, not the property’s current market value.¹ If your ex bought stock for $20,000 and it’s now worth $120,000, you take on that $20,000 basis. When you sell, you owe capital gains tax on the full $100,000 of appreciation, including the growth that happened while your ex owned it.

This matters at the negotiating table. An asset worth $120,000 with a $20,000 basis is worth far less after taxes than a $120,000 bank account. Compare assets on an after-tax basis, not face value.

Spousal Support

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

Agreements Finalized On or Before December 31, 2018

Under the old rules, the paying spouse can deduct the payments and the receiving spouse must report them as taxable income.³ Only cash payments (including checks and money orders) qualify, and payments cannot continue past the recipient’s death.⁴ If you modify a pre-2019 agreement and the modification specifically states that the post-2018 rules apply, the newer treatment takes over.

Agreements Finalized After December 31, 2018

The Tax Cuts and Jobs Act permanently changed the rules. For agreements executed after 2018, the paying spouse cannot deduct alimony, and the receiving spouse does not report it as income.⁵ This change is permanent and remains in effect for 2026 and beyond. Spousal support now moves as after-tax dollars with no tax consequence to either party.

Child Support

Child support is never taxable. The paying parent cannot deduct it, and the receiving parent does not report it as income.⁶ If you receive child support, leave it out of your gross income.

Retirement Accounts

Splitting retirement savings is one of the most tax-sensitive parts of any settlement. The rules split by account type.

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

To divide an employer-sponsored plan without triggering taxes, you need a Qualified Domestic Relations Order (QDRO). This is a court order that directs the plan administrator to pay a portion of the participant’s benefits to the former spouse.⁷ Without a valid QDRO, the plan cannot pay anyone other than the participant, regardless of what the divorce decree says.⁸

The transfer itself is tax-free. Distributions taken directly from an employer plan by the alternate payee under a QDRO are exempt from the 10% early withdrawal penalty, even if the recipient is under age 59½.⁹ That penalty exception disappears if you roll the QDRO funds into your own IRA and then withdraw them. The distributions are taxed as ordinary income either way.

IRAs

IRAs follow simpler rules. You don’t need a QDRO. Section 408(d)(6) allows a tax-free transfer of IRA funds between spouses or former spouses if the transfer is made under a divorce or separation instrument.¹⁰ A direct trustee-to-trustee transfer is the safest method. If you receive the funds personally, you have 60 days to deposit them into your own IRA, or the IRS will treat the distribution as taxable income.

Here is the key difference from employer plans: withdrawals from an IRA received in a divorce are subject to the standard 10% early withdrawal penalty if you’re under 59½. The QDRO penalty exception applies to employer-sponsored plans, not IRAs.⁹ Other IRA exceptions (disability, first home purchase, higher education) may still apply, but divorce itself is not one of them.

Selling the Marital Home

Under Section 121, a single taxpayer can exclude up to $250,000 of capital gain from the sale of a primary residence. Married couples filing jointly can exclude up to $500,000.¹¹ To qualify, 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 creates situations where one spouse moves out while retaining a stake in the home, and federal law accounts for this. If you receive the home from your spouse in the divorce, you can count your ex’s period of ownership toward the ownership requirement. And if your former spouse continues living in the home under a divorce or separation agreement, you’re treated as using the home as your primary residence during that period, even though you’ve moved out.¹¹ The spouse who leaves can still qualify for the $250,000 exclusion when the home is eventually sold.

If you keep the home, your basis is the original purchase price carried over from the transfer, not the value at the time of divorce. That matters years later if the home has appreciated significantly since it was purchased.

Filing Status and Claiming Children

Your filing status for the entire year is set by your marital status on December 31. If your divorce is final by the last day of the tax year, the IRS considers you unmarried for the whole year. If you’re still legally married on December 31, even after months of separation, you must file jointly or as married filing separately.⁴

Head of Household

Head of household status brings lower tax rates and a higher standard deduction than single or married filing separately. To qualify, you must be unmarried (or “considered unmarried”) on December 31, pay more than half the cost of maintaining your home for the year, and have a qualifying person (typically your child) living with you for more than half the year.⁴

Even if your divorce isn’t final, you can be “considered unmarried” 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 for more than half the year.⁴

Who Claims the Children

Only one parent can claim a child in any given tax year. By default, the custodial parent (the parent the child lived with for more of the year) gets the claim. If the custodial parent wants to release the child tax credit to the noncustodial parent, they must sign IRS Form 8332.¹³ A divorce decree is not a valid substitute for this form.

Form 8332 only transfers the right to claim 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. Those stay with the custodial parent.¹³ Both parents claiming the same child is one of the most common triggers for a post-divorce audit.

Joint Returns Filed During the Marriage

If you filed joint tax returns while married, both spouses are jointly and individually liable for any taxes owed on those returns, along with interest and penalties. That liability survives the divorce. A decree assigning the tax debt to your ex does not bind the IRS, and the agency can pursue you for the full amount if your former spouse underreported income or claimed improper deductions on a joint return you signed.

Federal law provides three forms of relief:

Innocent spouse relief, when your spouse caused a tax understatement through unreported income or improper deductions and you had no knowledge or reason to know about the error when you signed the return.¹⁴
Separation of liability, if you’re divorced, legally separated, or haven’t lived with your former spouse for at least 12 months. The IRS allocates the deficiency between you and your ex, limiting your liability to your own income and deductions.¹⁴
Equitable relief, when you don’t qualify for either of the above but holding you responsible would be unfair.¹⁴

To request any of these, file IRS Form 8857 within two years after the IRS begins collection activity against you for the tax year in question. If you’re going through a divorce and have concerns about joint returns filed during the marriage, raising them with a tax professional now is far easier than answering a collection notice years later.

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