April 15th is just around the corner and the IRS and the DOR are on my mind. A very clever tax lawyer colleague of mine, Jennifer Green, has written a good analysis of the tax issues which apply to divorcing couples.
DIVORCE AND TAXES
Although you had hoped that your marriage would last an eternity, you find yourself in the midst of a divorce. With all the emotions that you are experiencing, you may not be paying too much attention to the tax ramifications that result from a divorce. In addition to you, your spouse and your children, there is another interested party in your divorce, namely, the IRS. To avoid unexpected tax consequences on April 15, you should consider careful tax planning as part of your divorce. A few items of interest are described below:
First, you should consider the timing of your divorce. Although you may be anxious to have the divorced finalized as soon as possible, the proper timing of your divorce might actually save you in taxes. Federal tax filing status is set by your marital status on the last day of the tax year (December 31). If your divorce was finalized on December 30th, you and your former spouse can not file a joint income tax return for that year. You may get better tax results if you file a joint income tax return and therefore, you may be better off waiting to finalize your divorce in order to still be legally married on December 31.
Although a joint tax return is usually more tax advantageous for both spouses, the filing of such means that you have joint liabilities. If, however, you and your spouse are still legally married on December 31, you should compare the tax results of filing a joint tax return with a separate tax return. If you choose to file separate tax returns, each of you is responsible only for your own return.
As part of your divorce, you should consider contacting the IRS and state taxing authorities to see if you and your spouse owe any back taxes (plus interest and penalties) from previous years. Prior year tax returns that were filed jointly, create joint tax liabilities in which both spouses are legally responsible (unless one spouse can establish an innocent spouse claim). If you do owe money, you will want to make sure that all back tax issues get resolved during your divorce negotiations.
There is no tax gain or loss in transferring property between spouses during a divorce. Nevertheless, transfers of certain assets may create unexpected tax consequences. For example, if you plan to sell the marital home, the sale may create a potential capital gains liability. Although the sale of a primary residence can be sheltered from capital gains of up to $500,000, any amount over that threshold will result in capital gains.
Another tax consideration is whether or not a payment should be considered alimony or child support. Generally, alimony is the amount paid to a spouse for his or her living expenses, education, health or life insurance, property taxes, or mortgage payment. The person receiving alimony must pay taxes on the alimony in the year it is received, and the paying spouse may deduct the amount in the year it is paid.
Child support, unlike alimony, is tax neutral. It is neither taxable to the spouse who received the payment, nor is it tax deductible by the spouse who makes the payment.
Exemptions for dependents
You can continue to claim your child as a dependent on your tax return if the divorce decree names you as the custodial parent. If the decree is silent on that point, you would still be considered the custodial parent and thus eligible for the exemption if your child lived with you for a longer period of time during the year than with your former spouse. It is possible though for the noncustodial parent to claim the exemption if the custodial parent signs a waiver pledging that he or she won’t claim it.
Remember that if you’re the parent who claims the dependent exemption, you’re also the parent who has the right to claim the child credit and other education credits. It is important to realize that if you cannot claim the exemption for your child as a dependent, then you cannot claim those credits despite the fact that you are the one that actually paid the college bills.
Although you cannot deduct all fees charged by your divorce lawyer, you may be able to deduct the cost of tax advice given to you by your lawyer when preparing for the divorce.
IRS Updated Publications
The IRS has recently updated its publications for divorcing or separating spouses. The updates pertain to income tax filing status, exemptions, and innocent spouse relief.
IRS Publication 504 Divorced or Separated Individuals [January 10, 2011]
IRS Publication 971 How to Claim Innocent Spouse Relief [February 2011]
Publication 501 Exemptions, Standard Deduction, and Filing Information [Published January 5, 2011]
Publication 590 Individual Retirement Arrangements (IRAs) [Published February 3, 2011]
This post is not intended to be tax advice and cannot be used by any taxpayer either for the purpose of avoiding US tax penalties or for promoting, marketing or recommending to another party any tax-related matter addressed herein. As always, be sure to consult with your attorney or other tax professional regarding the tax implications for your specific situation.