Saturday, January 7, 2017

What you need to know about divorce and taxes



Did you get divorced last year, or are you in the middle of divorce now? If so, 2017 will be a different sort of year for you financially, particularly when it comes to your taxes.
Paying one’s taxes can be a complicated task in the best of times, but adding divorce into the equation can make things really confusing. However, looking at the biggest, most common questions—filing status, dependent exemptions, and taxable property—can help simplify the situation.

“There are a couple of different steps involved in the divorce-taxes waltz,” says certified financial planner Warren A. Ward of WWA Planning and Investments. “Although the divorce will be dealt with under the laws of the state in which the couple resides, federal laws and regulations may not necessarily be compatible with the terms of the agreement.”

Filing status—how do I choose the right one?

If you are part of a divorcing couple whose marriage has not yet been legally dissolved, you can file your taxes a few different ways: “married filing jointly,” “married filing separately,” or, in certain circumstances, as head of household. And whichever one you pick can have substantial impact on taxes.
Ward explains that, for tax purposes, a filer is generally considered “married” or “divorced” based on his or her marital status on the last day of the calendar year. “If you’re single on December 31, then you’re single for the tax entire year and vice-versa,” he explains. So couples who don’t finalize their divorce by New Year’s Eve may do their taxes as married filing jointly. Unless one spouse has complications that might create tax troubles, that’s typically the best option for both parties.
If you can’t agree to file jointly, then legally ending your marriage before December 31 can be best for tax purposes. Otherwise, each of you might have to file as married filing separately. And that can result in significantly higher taxes.
“There can be substantial cost associated with filing ‘married filing separately,’ so it should be avoided,” says Jessica Markham of Markham Law Firm. She advises clients who cannot agree to file jointly to “finalize their divorce before the end of the year.”

How do I sort out kids and exemptions?

If the divorcing couple has children, filing as head of household can be a desirable option for the custodial parent—the parent with whom the child spends more nights. This status not only offers lower tax rates than filing as married filing separately, it also allows the custodial parent to claim the offspring as dependents and thus get exemptions for each child.
Once the divorce is final, the head of household status can be particularly useful for the custodial parent, as it offers substantially lower taxes than filing as single. “In some sort of negotiated settlement, it’s not unusual for taxes to be pro-formed prior to an agreement being completed to make sure that the custodial parent can actually use the exemptions,” says Ward. “In the case of a litigated settlement, such niceties are sometimes skipped—even to the extent of obtaining an unusable exemption—in search of a winning outcome for one party or the other.”
Divorced parents can agree to alternate the dependency from one year to the next, or they can just hand over the dependency exemption if desired. Giving the tax exemption to the non-custodial parent is easily handled with a form 8332, although it’s not uncommon for an unhappy ex-spouse to sign the form, then file early claiming the child(ren) anyway. “Unhappy spouses have been known to complicate things with whatever tools may be available to them,” says Ward.

What if we still own property?

Who pays the taxes on joint property? “Income from joint property is generally kept by, and taxes owed by, the person who winds up with the asset,” according to Ward. “So if equal income is derived from different types of assets, divorcing earlier in the year and keeping the more tax-efficient asset can be an advantage.”
If the couple own…
  • Certificates of deposit or corporate bonds—taxable by both state and federal government
  • Municipal bonds—not taxable by the federal government, possibly taxable by the state
  • U.S. government agency bonds—taxable by the federal government but not by the state
  • Qualified stock dividends—receive favorable tax treatment by federal and most state revenue services
…then ownership of a tax-favored investment can offer an advantage to one party over the other, more so if the divorce is completed early in the year.
“If a home is kept by one party and various income-producing assets by the other, then agreement about claiming tax deductions for interest and real estate taxes should be part of the settlement,” advises Ward. “Again, filing earlier in the year and claiming greater deductions can be a tax advantage to the person who keeps the property asset.”

Deducting the divorce

Hoping to deduct the legal fees associated with getting a divorce? Sorry, but they aren’t tax deductible. The fees paid for tax advice regarding the divorce, however, may be. Ward explains that ending an untenable relationship often outweighs all other considerations, but attorneys and financial advisors should aim to structure a settlement that is both reasonable and tax-efficient.
Child support payments are not tax deductible either, and they are not taxable. Alimony payments, on the other hand, are both tax deductible (for the payer) and taxable (to the recipient), under certain conditions. A divorce attorney can write the specific requirements into the separation agreement or settlement.
Ending an untenable relationship often outweighs all other considerations, but attorneys and financial advisors should aim to structure a settlement that is both reasonable and tax-efficient.


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