Divorce is an all-too-common part of life, and with it comes important tax ramifications and decisions. Advise your clients with these 10 points on divorce and taxes:
Filing Status: Sometimes, couples (without children) will separate their lives, finances and living arrangements when going through a divorce. However, until you are officially divorced, you are still married and have only two filing statuses available: Married Joint and Married Separate. Depending on your circumstances, either one could yield a better tax result, so before both parties file, consider what filing status you will use.
Abandoned Spouse: You may be able to file as a head of household if you are separated but still legally married under the abandoned spouse rule. You qualify if:
- You have at least one child.
- Your child lives with you over 50 percent of the year.
- You can claim your child as a dependent.
- You pay the majority of household expenses for the year.
- You are filing a separate return and your spouse did not live with you.
Innocent Spouse Rule: If you filed a joint return that has an understatement of tax due to an error and omission, and you didn’t know about it, you can apply for relief from responsibility for the tax. While it can be tricky to prove, use Form 8857 to request the relief and have as many facts available, showing that you had no knowledge of the error. If you qualify, you will not be responsible for the tax, interest or penalties.
Alimony: Alimony (or spousal support) is often ordered as part of a divorce. These payments are usually a specified amount that must be paid until a date the judge decides, the former spouse remarries or some other event. Alimony creates a taxable event. This means that the spouse paying alimony will deduct that amount on their tax return, and the spouse receiving the payment will claim it as taxable income of their return.
Child Support: Just the opposite of alimony, child support is NOT a taxable event. So, payments made and received are not reported on the tax return. Make sure your divorce decree makes clear indication of what amounts are alimony and child support – the decision can have long-lasting effects on both tax returns of the former spouses.
Claiming Children: Easily one of the most battled areas of divorce can be settling the question of who claims the children on tax returns in future years. In most cases, the custodial parent will claim the children unless that parent signs Form 8332, “Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.” Both parties must understand that only one parent can claim each child in a tax year.
Division of Assets: Some assets produce income (stocks, bonds and businesses) and some do not (cash, homes and cars), so the division of assets in a divorce can make a large difference in the future tax bills of both spouses. Each party should research the tax ramifications of each asset and possibly run tax projections using different combinations of asset distribution.
Tax Deduction for Divorce Costs: Generally, any legal advice or other costs associated with a divorce are not tax deductible. However, there are a few exceptions, usually related to legal advice related to a taxable event. Here are a few examples:
- The amount you pay for legal advice related to alimony.
- Legal advice related to property transfers can be deducted on Schedule A.
- Any fees to obtain tax advice related to the divorce can go on Schedule A, too.
RA Accounts: Taxpayers are not allowed to deduct contributions to a former spouse’s traditional IRA if a final divorce decree or separate maintenance agreement is issued by year end. In this case, the taxpayer is only allowed to deduct contributions to his or her own traditional IRA.
Name Changes: You should notify the Social Security Administration (SSA) of any name changes after a divorce. The name on a tax return should match your SSA records and a mismatch may cause problems with the processing of a tax return and receiving a refund.
Editor’s Note: This article was originally published on March 1, 2016, and updated on Sept. 12, 2017. This is the first in a series of articles about life changes and tax. Stay tuned for another post very soon.