Tax Issues for Divorcing Couples
It is easy to get caught up in the emotional turmoil of divorce. However, it’s important to seek divorce advice in order to handle the financial issues that can come up during the division of assets. Property division, custody arrangements, and child support and alimony agreements are all divorce-related matters that carry significant tax implications. You must also consider how divorce will affect your individual income tax return, since your filing status and exemption planning will most likely change.
The more divorce advice and information you can obtain, the better off you’ll be. After all, it is the decisions that are made during the divorce proceedings which will determine your tax situation.
Taxpayers who have gone (or are going) through a divorce should consider the following divorce advice:
Filing Status Advice
If you are considered legally divorced as of the last day of the calendar year, you must file as ‘single’ or ‘head of household.’ You may also claim one of these statuses if you are not divorced but you have a legally binding separation agreement, or if you and your spouse have lived apart for (at least) the last 6 months of the tax year.
If you are still legally married as of December 31st and were still living together, you must use the status of ‘married filing jointly’ or ‘married filing separately.’ If the spouses do not trust each other, it is recommended that they file separately. (Additional advice: filing separately can limit potential tax benefits.) But if they decide to file jointly, they must understand that they are both responsible for the information on the return, as well as any consequences.
Depending on your specific situation, certain filing statuses may be more beneficial to you. As a bit of tax advice, ‘head of household’ and ‘married joint’ filers generally have lower taxes than ‘single’ and ‘married separate’ filers. So even if you are going through a divorce, you may try to file a joint return to save money and take advantage of this advice while you can.
Dependent Exemptions and Custody Advice
As for claiming dependent exemptions after divorce, the IRS generally assumes that the parent with primary custody will claim the exemption for dependent children on their tax return. However, divorced couples with 2 or more children may decide to divide the exemptions between them. The parent with the higher income typically gets a larger tax break from claiming dependent exemptions ? thus the couple may decide to allow that parent to claim the children.
Additional Advice: Even if you don’t have custody of your child, you still have the right to deduct their medical expenses if you paid for them. Many divorced parents forget to take advantage of this advice.
Alimony and Child Support Advice
A divorcing couple must also make decisions when it comes to child support payments and alimony payments. Child support payments are not deductible to the parent paying them; however, alimony is considered an above-the-line deduction for the payer. Alimony payments are also considered taxable earned income to the parent receiving them.
The parent who makes the child support payments is often the higher earner. They may, in fact, remit the money in the form of alimony in order to save on taxes. While the IRS does allow this, any alimony that resembles child support may not be fully deductible. It is important to understand the rules regarding divorce-related tax deductions before using this advice.
Division of Property Advice
Before a couple signs the divorce papers, they may transfer property tax-free ? typically as part of a property settlement agreement. The ownership of major assets (including cars or houses) can be signed over, or the property can be sold and the proceeds split.
The tax implications are more complicated if one partner buys out the other partner’s share of an appreciated property. The partner who retains ownership of that property should consider any taxes (e.g., capital gains) that may be owed once that property is eventually sold ? as a piece of advice, they should consider this before they agree to pay out half of the appreciated property’s value to the other partner. If one spouse leaves the marital home (while their ex continues to live there), a proper agreement would allow that spouse to maintain a stake in the property but avoid owing taxes when the house is eventually sold.
There is no doubt that a divorce will change the way you approach and file your taxes. For this reason, you should seek divorce advice from a professional before official proceedings begin. While divorce itself may be inevitable, there is advice you can follow to make it less harmful to your financial situation. Additionally, the decisions that you make after the divorce (especially if you have children) will greatly affect your tax situation.
There are a lot of tax issues to consider if you are going through a divorce. With the above divorce advice in mind, you’ll be headed in the right direction.