Since we discussed tax tips for newlyweds last week, and since almost 50% of US marriages result in divorce, here are some additional tax tips and considerations for married couples contemplating divorce. Attorneys and couples do not always realize that there can be unintended tax consequences in divorce settlements. While this list is not all-inclusive, it hopefully illustrates the need to seek competent advice from an experienced tax professional.
- A spouse typically engages a divorce attorney. Unfortunately for their clients, attorneys don’t always recommend that the spousal client engage a CPA. Since most couples’ records are in disarray, it makes good sense to engage a CPA who can organize and analyze the financial records.
- Remember that good tax advice given to one spouse is not necessarily good advice if given to the other spouse.
- Alimony is taxable to the recipient spouse and is tax deductible by the paying spouse. Calling payments “alimony” in an agreement or decree cannot be relied upon to constitute alimony as such payments may not necessarily meet the IRS’s definition of alimony. If the objective is to achieve non-alimony treatment, consider using language such as “The parties designate the payments as excludable/nondeductible under IRC sections 71 and 215.”
- To be awarded child or spousal support, which is not taxable to the recipient or deductible by the payor spouse, the court looks at each individual’s income, cash flows, noncash benefits, and an established level of expenditures and projects the needs of the recipient spouse and the ability of the other spouse to pay.
- If a spouse is self-employed, a valuation study can be done to determine the value of the business.
- Dividing of property is often governed by state law. If the person who purchased a property is being disputed among the spouses, a CPA can trace the funding of the property by examining the financial records of each spouse.
- CPAs can identify all of the assets and liabilities of the spouses and advice about the tax consequences as to how the assets are divided among the spouses. All assets are not treated equally under the tax law and CPAs can advise their client as to the most favorable way to divide the assets from a tax perspective. For example, while it is easy to change the legal title of a residence, the mortgage holder is very unlikely to release a spouse from the mortgage note. In addition, there are costs to dispose of certain costs such as real estate commissions.
- Retirement assets are often one of the largest assets. If the non-owner spouse is to receive as a settlement part of the other spouse’s retirement plan (403(b) or 401(k)), a Qualified Domestic Relations Order (QDRO) will be required to avoid immediate taxation on the benefits transferred to the former spouse. This order must be approved by the plan administrator and signed by the judge. Always have an expert complete the QDRO to avoid unintended tax consequences . . . such as the non-owner spouse receiving a retirement distribution tax-free while the owner spouse is responsible for the taxes on the distribution. QDROs do not apply to IRAs.
- Send the IRS change of address Form 8822 if applicable.
- Who gets to claim the children as dependents? Generally the dependency exemption goes to the spouse who is the custodial parent unless that right is waived. The fact that a divorce decree awards the exemption to a noncustodial parent is not determinative for tax purposes. IRS Form 8832 is used to allow the non-custodial parent the right to claim the dependency exemption. In some divorces where there is more than one child, the spouses sometimes split who can claim which child. Determining which child should be selected as a dependent is a tax consideration.
- The dependency exemption goes beyond getting a tax deduction for a dependent. It also affects the ability of a parent to claim other tax breaks, including head of household status, the child tax credit and the earned income tax credit. High income wage earners may not be able to benefit from claiming a tax dependent, and can negotiate this right to the other spouse.
- Talk to your CPA about your filing status and your federal income tax withholding allowances. Filing status can be affected by date of divorce and dates spouses lived together during the year. Married filing jointly results in a joint and several tax liabilities for each spouse; married filing separately could result in loss of certain tax credits; head of household requires a dependent.
- After a divorce, one spouse may want to escape liability for taxes related to income or deductions of the former spouse and could possibly seek relief under the innocent spouse rules.
- Claiming the standard deduction versus itemizing deductions can be an issue between the spouses when filing as married filing separately.
- Legal fees paid to a divorce attorney are generally not tax deductible. If tax planning is received from tax counsel, be sure that those fees are itemized as they are deductible on Sch. A as an itemized miscellaneous deduction subject to the 2% floor.
- Divorced spouses may be eligible for social security benefits due to coverage rules under former spouse – timing of divorce could be crucial.
Note: Because each individual has unique factors needs that need to be examined when determining that individual’s tax situation, we invite you to call 610-594-2601 today to make an appointment to discuss your personal tax situation. You can also schedule a free consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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