This is the seventh post in my “Divorce & Your Money” series.
Taxes are never fun, but there are new things to consider when it comes to divorce.
If your divorce is final by the end of the year, you are considered unmarried for the entire year. Your tax filing status would be “Single” or if you have a dependent, “Head of Household” (HOH).
Married persons generally file jointly (MFJ) or separately (MFS). (Same-sex spouses must currently file as “Single” with the IRS, however.)
In general, Head of Household (HOH) is the most favored tax status, and Married Filing Separately (MFS) is the least favored. HOH provides a larger standard deduction than Single, and certain deductions are lost when you file MFS.
In some cases, a spouse may be able to file as HOH before the divorce in finalized. A married person may be considered unmarried and eligible for head of household status if their spouse was not a member of the household for the last six months of the year and the household is the home of a dependent child.
There are tax benefits to claiming a dependent, such as:
- The exemption for the child.
- The child tax credit.
- The credit for child and dependent care expenses.
- The exclusion from income for dependent care benefits.
- The earned income credit.
In general, the dependency exemption for children of divorced taxpayers will go to the parent who has custody of the child for the greater part of the calendar year. Each child may only be claimed by one person.
In cases of joint custody, where children are truly living with and being supported by both parents, there are several alternatives. The parents could agree to alternate claiming the exemption each year. With two children, both could file as Head of Household (HOH), claiming one child each.
In general, alimony or maintenance payments are taxable income to the recipient and are deductible by the payer. Therefore, it is generally advantageous to classify payments as alimony when the payer is in a higher tax bracket than the receiver. Child support is tax neutral: it is neither taxable to the recipient nor deductible by the payer.
Since there is a tax advantage to paying alimony, there may be an incentive to call property settlements or child support alimony when they are really not.
Of course, the IRS doesn’t like that, so there are two rules to keep in mind:
- Alimony Recapture: This rule looks at the first three years of payments, to determine if a property settlement is being disguised as alimony.
- Events in Child’s Life: If alimony ends within 6 months of a significant date for the child (turning 18, entering college, turning 21), it could be considered child support.
If an alimony payment is deducted, and later deemed to be child support, the taxpayer could owe taxes and penalties retroactively. Your accountant, attorney or financial planner should be on the lookout for these.
Liability on Joint Return
Married persons filing jointly are both responsible for the accuracy of the return, and the payment of any tax due.
However, Innocent Spouse Relief is available in cases where one believes one spouse (or former spouse) should be fully liable (in the case of tax fraud, for example). You may request relief from liability for tax, plus related penalties and interests if you: (1) filed a joint return and (2) are no longer married to (or are legally separated from) the spouse with whom the joint return was filed. Consult an attorney or your accountant if this may apply to you.
I consider myself knowledgeable about many taxation issues. However, I do not provide tax advice, and I do not prepare tax returns. If you have specific questions about the tax implications of a divorce, you should speak to a licensed tax expert.
Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation. You should discuss tax or legal matters with the appropriate professional.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Sara Stanich and not necessarily those of RJFS or Raymond James.