Understanding the Tax Implications of Divorce

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Divorce can already be deeply complex—legally, financially, and emotionally. Adding the California Tax Code to your divorce proceedings only adds to the uncertainty and distress of the situation. If you are unfamiliar with divorce law, then you are likely just as unfamiliar with the tax laws surrounding divorce. Let the Law Office of Michael R. Young help you navigate the uncertainty of family law.

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Is Joint Filing Still Available During the Divorce Process?

Selecting the appropriate tax filing depends on whether the divorce has resolved. If the divorce process continues beyond December 31st of the applicable tax year, both parties may agree to a joint return. “Married filing jointly” is allowable, even if the parties have been legally separated for some time, provided that the divorce has not been finalized by the court. Both parties must use joint filing on each of their returns. However, when divorce has been finalized prior to December 31st of the tax year, joint filing is not permitted. At that point, the only available filing statuses are “Single” or “Head of Household.”

It is important to discuss filing statuses with your attorney, as well as a professional tax advisor. Generally, a joint return provides tax benefits. As a result, tax burdens are reduced based on income, deductions, and credits. However, both parties are jointly responsible for any tax obligations, including interest and penalties.

Because filing jointly generally provides a benefit to both parties, doing so can be a negotiating tool; showing good faith and a willingness to cooperate. On the other hand, it is possible for one spouse to agree to a joint return, but later back out. A court will not force the unwilling spouse to file the joint return, and it is very rare for the IRS to accept a joint return with only one spouse’s signature.

My Spouse Won’t Agree to a Joint Filing—How Should I File?

If both parties cannot agree to a joint filing before the divorce is finalized, there are two options for filing:

• Married Filing Separately
• Head of Household

Head of Household provides for the benefit of a larger tax deduction and better tax brackets, provided that you meet certain criteria. You must have a dependent residing with you for at least six months of the tax year, and you personally must have financially contributed to at least half your home’s upkeep.

What Liability Exists on a Joint Return?

If you and your soon-to-be ex-spouse agree to file jointly for your last tax year, understand that you both may still be subjected to joint tax liabilities. For example, if one spouse claimed too many allowances during the tax year, creating a $5,000 tax bill to the IRS, both parties will be jointly responsible for paying that bill. For these reasons, it is important to have your attorney and tax advisor review both parties’ tax issues prior to making the decision as to whether you will file separately or jointly.

What About Spousal & Child Support?

Spousal support is considered taxable income to the receiving spouse, so it is deductible to the spouse making the payments on income tax returns. Child support payments, however, cannot be deductible by the paying spouse, nor are they counted as taxable income for the receiving spouse.

There are other considerations that must be taken into account when making spousal support payments:

• “Front-loading” spousal support payments is not acceptable to the IRS, so it will create tax consequences. This is to prevent concentrated payments to the receiving spouse shortly after divorce, to avoid paying the sum total over a period of time. The IRS considers front-loading to be a form of “property settlement.” Property settlement does not allow spousal support tax deductions to be applied to the paying spouse.
• If alimony payments to a custodial parent cease within 6 months of a child’s 18th or 21st birthday, the IRS may launch an investigation into the nature of the payments. Why? Because, if the nature of the payments appear to have been for the benefit of the child until the age of maturity, the IRS will classify the payments as child support.

Remember that child support payments do not have the same tax benefits for the paying spouse.

Who Gets to Claim the Dependency Exemption for Children?

Under both Federal and California tax laws, the custodial parent may claim a dependency exemption for all of the children on his / her tax returns. However, in cases where the divorcing parties are able to reach amicable agreements, they can agree to override the dependency exemption.

This allows the parents to decide who will claim the exemption each tax year. An additional benefit of reaching a dependency exemption agreement is that it will not have an effect on the party claiming a head of household filing status. Furthermore, provided that the claiming spouse’s income is not too high, he or she may be entitled to an additional $1,000 per child tax credit for each child under the age of 17.

What Other Tax Deductions & Credits Are Available?

Even if your ex-spouse has retained custody and claims child exemptions, you may be entitled to additional deductions on annual taxes. For example, if you continue to pay your children’s medical bills, you may include them as a medical expense deduction, regardless of custody. While you may not be entitled to claim the child tax credit, due to your ex-spouse’s custodial status, you may still claim the childcare credit for any work-related expenses incurred for the care of children younger than 13.

What About the Sale of the Marital Home or Retirement Funds?

Generally, the couple will own a marital home at the time of divorce that will no longer be occupied by either party. If the decision is made to sell the home upon divorce, there may capital gains taxes that apply to either party. Typically, these taxes may be avoided if you lived in the home for at least 2 of the past 5 years of ownership, which will allow you to exclude the first $250,000 of gained capital from your taxable liability and the sale occurred prior to the finalization of divorce. If divorce is finalized prior to the sale of the home, the $250,000 reduced exclusion may qualify even if the 2-year test is not satisfied.

It is common for retirement assets to be included in a divorce settlement, where one spouse who has gained considerable retirement savings is required to transfer a portion.

If the money is withdrawn from a retirement account and given directly to the ex-spouse, the IRS will deem this to be a taxable event. This is avoidable, however, by setting up the transfer to occur under a QDRO. This will allow your ex-spouse to receive the funds and avoid a tax consequence on your end.

Call (909) 315-4588 for a Consult About Your Taxes & Divorce

It is important to sit down with a both an experienced attorney and tax advisor during the divorce process. Our legal team at the Law Office of Michael R. Young has demonstrated experience in navigating and negotiating the tax implications associated with divorce.