Divorce Can Destroy You At Tax Time
We found this article at dailyfinance and thought that we would share it and give our thoughts.
Divorce is one of the hardest things you may ever go through — both emotionally and financially. But while you’re focused on your now-adversarial relationship with your ex, you shouldn’t forget to keep an eye on another entity that may be after a larger chunk of your assets thanks to your split: The IRS. Turns out, divorce has a huge impact on your taxes, and knowing what’s at stake can help you avoid major complications later on.
Here are some of the things to keep in mind as you go through the divorce process.
Checking the box for either married or single may seem like the simplest thing in the world, but it gets complicated with divorce. The IRS wants to know your legal marital status as of the end of the year you’re filing for. So even if you’ve filed your paperwork, if your divorce isn’t final by Dec. 31, then you’ll be considered married for the year.
However, there’s an exception that allows separated parents to claim the favorable head of household status, which gives you greater deductions. To qualify, you must have paid more than half your housing costs for the year, lived apart from your spouse during the last six months of the tax year, and your dependent child must have lived in your home for more than half the year.
Exemptions for Children
The question of who gets to claim exemptions for children can make a huge difference to your tax bill. Typically, the test depends on which parent the child lives with for more than half the year. But divorced or separated couples can essentially pick who gets the exemption for children by signing a written declaration. With the current write-off at $3,700 per child, the decision you make can determine which of you will get up to $1,300 in tax savings.
Alimony, Maintenance, and Child Support
Payments between former spouses under a divorce decree fall into different categories. Cash payments that qualify as alimony are deductible by the person who makes them and are counted as income for the person who receives them. But you can generally agree to reverse that treatment and avoid any tax consequences for payments if you prefer.
Child support, on the other hand, isn’t deductible by the payer or counted as income by the recipient or the child. So as you describe certain payments in your divorce agreement, be careful because the description can change the way those payments get taxed.
As part of a property settlement, a spouse may be entitled to part of the other spouse’s IRAs or employer-sponsored retirement account. For 401(k)s and other employer plans, a qualified domestic relations order can allow you to get benefits from a spouse’s plan and treat them as if they’re your own, thereby avoiding potentially disastrous tax consequences. Under certain circumstances, you may be able to roll 401(k) money into an IRA of your own.
In general, neither spouse will realize any capital gain or loss or other tax consequences from receiving or giving up property in a divorce decree. But if you later sell property that you received due to divorce, you’ll then have to pay taxes on gains, based on the original tax basis of the property you received.
To be treated as part of the divorce, a property transfer must be complete within a year of the date the marriage legally ended, unless it was specifically provided for under the divorce agreement. In that case, you have up to six years to make transfers, although later ones may still be valid if you can show valid reasons for the delay.
Finally, most states treat each spouse’s income as his or her own, even when it’s jointly reported on a tax return. But in community property states, which include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, different rules may apply. As a result, you may be treated as having earned part of your former spouse’s income during the year in which you divorce.