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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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