Family Law: Divorce and Taxes
Divorce often presents tax issues that need to be resolved, including those relating to property and debt, spousal maintenance, child support and sometimes previously filed (or yet to be filed) tax returns. Because of the complexity and high stakes associated with divorce and taxes, this area is one in which you should try to keep the communication open and the emotions out. It will only benefit Uncle Sam if you file separate tax returns out of spite when filing jointly is beneficial. Do not assume that you will be able to claim all deductions and exemptions. That will only lead to fines, penalties and audits if you are wrong. Make sure that all tax-related issues are settled and clearly stated in your Property Settlement Agreement and/or Decree and Order of Child Support. Several issues arise related to divorce and taxes:
- Filing Status: How are you going to file your taxes? Determine the most financially feasible way to file. Typically, filing a Married Joint Return will result in the lowest taxes. Hint: Do not look at a joint return as any kind of “attachment” to your spouse; this decision is strictly financial. If you are divorced before December 31 of the tax year, you cannot file a joint return for that year.
- If you do sign a joint return, the law holds both you and your spouse responsible for the entire tax liability. This is called joint and several liability. Joint and several liability applies not only to the tax liability you show on the return but also to any additional tax liability the IRS determines to be due, even if the additional tax is due to income, deductions, or credits of your spouse or former spouse. You remain jointly and severally liable for the taxes, and the IRS can still collect from you, even if you later divorce and the divorce decree states that your former spouse will be solely responsible for the tax obligation. If you are going to do a joint return after separation, you should use a CPA or qualified tax preparer to avoid any mistakes or problems.
- If you have wrongfully been held responsible for your spouse’s obligation, you can claim that you are an “innocent spouse” and file the appropriate forms with the IRS. Here, you argue that you did not know, and had no reason to know about any under reporting of income or other wrongdoing associated with the filing of the return and therefore should not be held responsible for paying any additional taxes, penalties or interest due.
- Exemptions: You may claim a child that does not live with you only if it is stated in your Order of Child Support or if mutually agreed upon. Allocation of the tax dependency exemption may be modified by the court upon the filing of a Petition to Modify by either party. If it can be shown that it would be in the best interest of the child for the non-residential parent to claim the child as a tax dependency exemption, the court can award the exemption to the non-residential parent. Where there is more than one child of the marriage and one of the parties has a small amount of income, the tax dependency exemption and child tax credit may not be taken advantage of if that party claims all of the children. At certain income levels, claiming more than one child may not increase the tax refund of the lesser earning parent, whereas the party with greater income could save thousands of dollars each year if the tax dependency exemptions are properly allocated. For this reason, allocation of the tax dependency exemptions is a very important part of every divorce with minor children.
- Liabilities and Refunds: Taxes owed, or refunds received for time periods before the separation, are usually treated as “community” assets/liabilities and are therefore, split equitably between the parties. In the heat of the moment, some spouses will intercept a tax refund and cash it without the other’s knowledge. All funds must be accounted for and it is likely that if a spouse engages in this behavior their share of the final property settlement will be reduced.
- Child Support and Maintenance: Child support is not considered income for the receiving parent and is not deductible for tax purposes for the paying parent. Spousal maintenance is considered income for the receiving parent (they must pay income taxes on the money received), and is tax deductible for the paying parent.