Did you know that, in America, there is one divorce about every 36 seconds? That’s nearly 2,400 divorces per day, 16,800 divorces per week and 876,000 divorces per year.
With tax season upon us, that means approximately 876,000 people are newly navigating the realm of post-divorce taxes. Taxes are complicated enough as it is, but when you add in assets, dependents, alimony, child support and other freshly split obligations, filing can be downright daunting.
Here, the five most important things to keep in mind when facing this new challenge.
1. Marital status is set as of Dec. 31, not April 15
If your divorce was finalized after Jan. 1 but before you filed your taxes, you are still officially married as far as your 2014 taxes are concerned. In other words, your marital status as of Dec. 31 determines your filing status for that entire calendar year.
Although you cannot file jointly, you may be able to file as a head of household, depending on particular qualifiers such as length of cohabitation, cost of home upkeep, et cetera.
2. Home is where the taxes are
Upside: You don’t have to pay taxes on transferred property in a divorce, and if you’re retaining the residence, you can claim the mortgage interest deduction.
Downside: Now that you’re single, capital gains exclusion laws work less to your advantage. As a result, if you eventually decide to sell your home, your profit from the sale may be significantly reduced.
3. Alimony is tax deductible, with some caveats
In most cases, alimony is tax deductible for the party paying it; in fact, it’s an above-the-line deduction, meaning it does not need to be represented as an itemized claim. However, a few conditions should be kept in mind:
- Alimony payments made while both parents of the child are still living together are not tax deductible.
- While cash, checks and money orders meet alimony standards, property contributions do not.
4. Custodians clean up on tax returns
Modern custodial agreements rarely designate a sole custodian, which makes taxes a little more difficult. Typically, the custodial parent is considered, by default, the parent who has physical custody for most of the year. However, many couples now alternate who claims custody each year in order to share the tax benefit.
Also, keep in mind that child support is always tax-neutral, which means that even if you’re paying it, it is not tax deductible in any way.
There’s one little loophole, however. If you continue to pay a child’s medical bills, even without custody, those costs can be included as a medical expense deduction.
5. Be careful with your 401(k)
Your retirement should be handled with the same care it took to earn it. Cashing out a 401(k) to use in a settlement is subject to taxes; however, this tax trap can be avoided if the transfer is done under a qualified domestic relations order, or QDRO. A QDRO grants your ex-spouse the right to the funds without the imposition of taxes.
As always, if you have any doubts about how to file your taxes due to a divorce, contact your attorney and your accountant. They are best qualified to give advice for your unique situation.
Filing taxes during or after a divorce can be more complicated than expected for the parties. It is important to understand a variety of tax issues unique to divorcing parties in order to avoid unexpected short- and long-term issues.
In Part One of this article, we introduced some of the most common tax issues facing individuals during and after divorce. Here we offer several more things you must know when going through a marital dissolution action.
The Filing Status to Use While the Divorce is Pending
Many people inaccurately believe that once a divorce is filed, they are no longer entitled to file as “Married Filing Jointly.” This it not true. IRS code allows a taxpayer who is married on the last day of the calendar year to file as either Married Filing Jointly, Married Filing Separately or, in some cases, Head of Household.
The IRS makes no distinction for people going through a divorce in any given year. Even if the final court date is scheduled for January 2 of the following year, so long as the parties are still legally married (with no legally binding divorce decree or separation maintenance order in place) on December 31 of the current year, they are entitled to file as Married Filing Jointly. This can be beneficial, as most married couples enjoy greater tax benefits when filing under this status. At the very least, this will shave off a bit of tax liability for the current tax year.
Some Legal Fees Can Be Deducted
One of the most common questions asked by divorcing parties is whether they can deduct their legal fees on their tax return. Unfortunately, while the IRS does allow for the deduction of legal fees related to tax advice from your divorce lawyer, the balance of his or fees is non-deductible. For this reason, it is critical to ensure your divorce lawyer prepares an itemized invoice, as it is your responsibility to provide support for any deductions you take.
How the Property Division Can Impact Taxes
For most divorcing couples, the majority of their marital estate is comprised of retirement accounts. In most cases a Qualified Domestic Relations Order (QDRO) is required to effectively divide these assets. However, there are tax consequences for a spouse receiving a share of the other spouse’s retirement accounts. It is important to fully discuss the potential tax liability – and ways to avoid them – with your divorce attorney or financial planner.
To learn more about divorce tax filing please contact our office.
Source: Tax Issues and Divorce – Part 2 | Robert Hetsler,J.D. CPA,CVA,CFF,FCPA,MAFF,CMAP,PFP | LinkedIn
As if divorce doesn’t cause enough emotional and financial turmoil, every person going through a divorce must also consider a variety of tax issues that arise once a marriage ends. Many of these issues can catch a divorcing spouse off guard. It is important to understand these tax pitfalls in order to make sound decisions and avoid unnecessary troubles down the road.
Alimony is Taxable to the Recipient
With some exceptions, spousal support paid by one party to the other is usually considered a taxable event for both. This is crucial to understand because it causes a tax liability for the payee spouse and a tax credit for the payor spouse.
The IRS sets forth specific criteria in order for a payment between spouses to qualify as alimony:
- The spouses do not file a joint tax return with each other
- The payor spouse pays in cash (including checks, bank transfers or money orders)
- The payment is received by (or on behalf of) the payee spouse
- The divorce or separate maintenance decree does not state that the payment is not alimony
- If legally separated, the former spouses are not members of the same household when the payment is made
- There is no liability to make payments after the death of the payee spouse
- The payment is not treated as child support or part of a property settlement
Who Gets the Dependency Exemption for the Minor Child
The IRS presumes that the custodial parent will receive the dependency exemption for any minor children of the divorcing couple. A custodial parent is defined as the parent who has the minor children for the greater portion of the calendar year. This presumption can create a situation where one parent always gets the deduction, year after year, providing significant tax savings to him or her.
However, the dependency exemption can be allocated by agreement of the parties or by court order. In such cases, the parent relinquishing the dependency exemption is required to sign IRS form 8332, which is then attached to the non-custodial parent’s tax return in each year that he or she claims the exemption.
See Part II of this article.