The following are the most commonly asked questions asked by divorcing couples during tax season. (The additions which I have added are italicized and contained in parentheses.)
1. Do we file jointly or as individuals? The law states that every individual must file according to his or her marital status as of December 31st in any given year. Some parties might consider delaying finality to their divorce until after the New Year so that they may reap the benefits of filing jointly. An agreement should be made in advance as to the refund or deficiency in this case.
(I would clarify that the agreement should concern how to share the refund or liability. It may not be the same for the refund as opposed to any liability based on the equitable factors involved in that particular set of circumstances.)
Alternatively, if you are still going through a divorce, you can file “married filing jointly” or “married filing separately.” If there are concerns about income, such as a question about whether or not one party is reporting all income or withholding cash received in an effort to defraud the government, you may want to file separately or obtain indemnification from your spouse’s representation.
2. Who claims the children? Unless there is an agreement or Court Order stating otherwise, the designated primary custodial parent has the right to claim the child, or children. If your divorce is still pending, it may make sense to include a provision that states if the person entitled to claim the exemption will not benefit from the deduction, the other person shall be entitled to make the claim. The most common settlement, as to this issue, is having the parties split the exemptions.
(If one party will benefit more from the deduction, the foregoing should apply but a certified accountant should make that determination. Any party who relinquishes their right to a deduction should be otherwise compensated by the accountant’s calculations in order ensure the equitable resolution of these issues.)
3. How do we divide our assets for tax purposes? For couples in the midst of a divorce, asset division can be complicated. However, for already divorced couples, this would be detailed in the divorce agreement. Reference your prior agreements or Court Orders as to how to split the deductions. Here are some examples:
• If one party is buying out the other’s equity in the marital home, normally the person retaining the asset will be entitled to the deduction (such as a mortgage or property tax deduction).
(If the buyout takes place mid-year, then the deduction should be proportionately allocated as the parties contributed. Once the buyout has occurred, the party making the future payments is entitled to the deduction.)
• If property is being sold, the deduction can be divided (make sure to examine, with your accountant, any cost basis issues).
• If you are still in the process of getting divorced, deductions can be divided, or parties can file jointly. (See above.)
• If one party will be liquidating an IRA or 401k, they will have to pay taxes on this income, unless of course the taxes were already paid as would be in the case for a Roth IRA or a Roth 401K. Keep in mind that dividing such an asset in divorce does not necessarily create any tax impact; it is the liquidation that creates the liability. If you utilize a Qualified Domestic Relations Order (QDRO) to divide a retirement account incident to a divorce, tax implications may be avoided unless liquidation ultimately occurs.
(Use an expert and obtain a Domestic Relations Order so you don’t have to pay taxes or penalties on these assets.)
4. How do we file for different types of support? The three main types of support are alimony, child support and pendente lite support, which [are] often used to provide for the support of a lower income spouse while the legal process moves ahead.
• Alimony is normally taxable to the payee, the person receiving the payment, and deductible to the payor, the person paying the alimony. Parties can agree otherwise, which is common in military divorces where not all income is taxable. If the agreement states that alimony is not taxable, the agreement must be attached to the tax returns.
• Child support has no effect on taxes. In other words, if you are paying child support to your former spouse, you are not entitled to a deduction and the person receiving the child support will not claim the payment as income.
• Pendente lite support should be requested as unallocated and non-taxable if you are the receiving party. If it is not deemed as unallocated, this potentially could be a taxable event to the payee.