Divorce and Taxes
Divorce is often a time of financial strain and confusion. Despite the trying times, the Government still expects you to file your taxes accurately and on time, which may very well require cooperation with your ex.
We assume you are reading this before you divorce. Perhaps the best way to prepare yourself would be to read IRS publication 505 "Divorced or Separated Individuals". Determine with your tax advisor which tax filing status will be in your personal best interest, and drive your negotiations in that direction.
Filing Your Taxes
Can you file a joint tax return for the previous tax year?
The answer is ... maybe. If you weren't Legally Separated in the prior tax year, you can file a joint return. Your federal income tax filing status is determined by your marital status on the last day of the tax year. Being Legally Separated often requires a specific court document in many states but you should check with your state laws. If you qualify to file jointly, your spouse may not be cooperative and you may be forced to file Married-Filing Separately. Even if your ex is willing to file with you, are you sure you want to do that?
If your ex has been involved in any shenanigans (questionable tax deductions or under-reporting of income), you may decide to take this opportunity to get away from any illegalities by filing Married-Filing Separately. Just know that in most cases Married-Filing Jointly is the most advantageous in most cases.
Can you file as Head-Of-Household?
To qualify, you must be either unmarried or considered unmarried on the last day of the year. Under the IRS Abandoned Spouse rule, you must have lived apart from your spouse during the last 6 months of the year to be considered unmarried.
The other 2 hoops the IRS makes you jump through are: 1.) You must have paid more than half the cost of maintaining a home on the last day of the year, 2.) a dependent child or relative must have lived with you for more than half the year or you have a dependent parent (dependent parents aren't required to live with you). If you are able to file as Head-Of-Household will likely cause your tax rate to be lower than the rates for single or Married-Filing-Separately.
Another way to view qualifying status for Head-Of-Household:
-You and your ex-spouse haven't lived together during the past six months,
What if you are forced to file Married-Filing-Separately?
Potential hazards to filing separately include your ability to chose between the standard and itemized deductions, the possibility of being disallowed tax credits (earned income, dependent care, education credits or deductions), the clawback of previously exempt interest income or the benefits of Roth IRA contributions or conversions.
The IRS presumes that the custodial parent is entitled to the exemption for children. The custodial parent may, however, "trade" the exemption to the non custodial parent using IRS Form 8332. You may wish to negotiate this exemption with your spouse. Parents will sometimes alternate the deduction each year. We suggest you agree on who takes the deduction in what years before the divorce is finalized, and put that agreement into the final document.
We suggest you factor these considerations into your divorce agreement. If your spouse refuses to agree to file jointly, it may cost you more out-of-pocket, and you might demand adjustments to the division of assets to compensate you.
Child Care Tax Credits
Child care credits on your tax filing form are only available to the custodial parent. Child support payments are neither tax deductible nor taxable to the person receiving the money. Alimony is tax deductible to the sender and taxable income to the recipient.
A QDRO (Qualified Domestic Relations Order) may be necessary in order to divide assets in a tax-sheltered retirement account. QDRO's are court orders.
Some costs associated with the cost of tax advice given you by appraisers, actuaries and accountants can be tax deductible. Ask your advisor.
If you are the custodial parent and paying a child's college expenses, you may be eligible for the Hope Scholarship Credit and Lifetime Learning Credit on your taxes. If you have 'traded' or are alternating taking child exemptions, you may take the Hope Scholarship Credit and Lifetime Learning Credit in years where you claim the child as an exemption on your taxes.
Pay particularly close attention to marital assets that have a low cost basis, as that cost basis gets inherited by the person who receives the asset in the divorce settlement. One does not want to be stuck solely with highly appreciated assets if any of them might be sold in the near future. Consider the after-tax value of these assets.
Speak with your tax advisor early on in the divorce process. You may want to adjust your withholding in anticipation of a changed tax status later in the year.
Time Your Divorce If You Can
Be aware that if your divorce is finalized on or before December 31 of a year, then, according to the IRS, you are considered unmarried for the entire year. This is a fact you may want to consider when planning the timing of your divorce.
You and your spouse can continue to file joint tax returns even after you are separated and have filed for divorce. However, if you signed a joint tax return that is fraudulent you are liable for the money owed unless you can show you were an "innocent spouse."