Divorce & Taxes: Making Sure You're Ready For The Big Day
It's one month and counting - Tax Day. If you divorced in 2015 or are about to finalize your divorce this year, you'll need to put a big red circle around April 18th in your calendar, as you've got some work to do.
Let's look at how far along the divorce process you are. The key date here is December 31st. If you finalized your divorce by December 31st last year then it's simple - you file your own tax return as either '”single” or “head of household.”
But, the path to take is less obvious when you're in the middle of a divorce. You can file a joint return, if you both agree to. If you’d prefer to work alone on this, you can also file as “married filing separately.”
To File Together, Or Apart?
Your first instinct could be to have as little contact with your ex as possible, and complete your own return. The best idea is to set emotion to one side and try to think about the end result. Your tax burden is usually lowered by filing jointly, depending on your respective incomes, credits and deductions.
Before you rush to pick up the phone and set up a tax meeting with your ex, be aware that you will be liable for your former partner's tax deficiencies and penalties. Talk things over with your tax advisor and attorney - they will help you to make the best decision.
If you were part of a same-sex married couple and divorced last year, then you have the option to file joint state tax returns. However, if you were in a registered domestic partnership or civil partnership, you cannot file joint federal returns.
If you are the spouse who pays alimony, the good news is that you can take a tax deduction for these payments.
But - and there's generally a but when it comes to the law and taxes - you need to have fulfilled certain obligations first. This is when those people who like to have i's dotted and t's crossed look a little smug. You will need to have a record of your ex-spouse's Social Security number so you can report it on your return, and you must have set out alimony cash payments in your divorce agreement.
If you receive alimony, you will have to pay tax on these payments.
What About The Kids?
Living arrangements can make tax returns complex. If your child lived with you for a longer period of time last year, then you should claim them as a dependent. You will be known as the 'custodial parent' and will be eligible to claim certain credits:
Child credit (up to $1,000)
Child care credit for work-related expenses you incur to care for child under 13-years-old (up to $6,000)
American Opportunity higher education credit (up to $2,500)
Lifetime Learning higher education tax credit (up to $2,000)
On occasion, a custodial parent will choose not to claim tax exemption for the child. Providing they sign a waiver to this effect, the non-custodial parent can claim this. If you're in this situation, pay attention - this will save you money.
If you pay child support, you don't get a tax deduction. If you receive it, you don't pay tax on it.
Kids tend to need a few trips to the doctor; if you pay their medical bills, be sure to include these in the medical expense deduction section of the return. You can do this even if you don't have custody of the child.
Your House (and Other Assets)
One of the biggest purchases most people make is their house. It follows, if a couple decide to sell it following a separation, this transaction has tax implications. You can avoid tax on the first $250,000 of gain on the house sale, providing you have lived there at least two years out of the last five. If you choose to file jointly, you can avoid tax on the first $500,000 of gain (providing you've both used it as your home for the two out of five years).
The two year stipulation is important, but if you haven't lived in the house for that duration, you can still receive a proportion of reduction, depending on the length of time you were in the house. So, if you spent one year there, you will be eligible for a tax deduction of $125,000.
If assets have been transferred from one spouse to another, the recipient won't have to pay tax on the transfer. But, if you've received assets from your ex-spouse and decide to sell them, you will have to pay capital gains tax on the appreciation before and after the transfer.
Have a Good Attorney
If you hired a decent attorney during your divorce, you won't have cashed out your 401(k) plan to give money to your spouse. If you did this, the bad news is you'll have to pay tax on it as the IRS considers it a taxable distribution. This is obviously not ideal.
You won't have to pay tax on the transfer if it was carried out under a Qualified Domestic Relations Order (QDRO) (this is an order that's signed by a judge and sent to the Retirement Plan Administrator) and set out in the divorce agreement.
Did Your Attorney Bill Accurately?
The IRS allows for the deduction of legal fees for the time your attorney spent advising you about tax. You need to prove this, so approach your attorney for the logs.
Taxes won't ever be the most exciting dinner party conversation, but it’s worth knowing your stuff when it comes to taxes--especially during a transitional period when things can get confusing.
If you have any questions and would like to consult with someone on our team, give us a call: