10 Tax Tips for Divorce
Though we just turned the calendar page to February, April 15, the income tax filing deadline will soon be upon us. John Eory in the New Jersey Law Blog offers a number of pointers about divorce and taxes, which I will take the liberty of quoting extensively:
- Alimony paid in accordance with a properly drafted divorce agreement or Court Order is deductible to the person paying it and reportable as income to the recipient. Thus, if you are receiving alimony, you must set aside a sufficient portion to pay federal and state income taxes in order not to be unpleasantly surprised come tax time.
- Child support is "tax neutral"; non-deductible to the payer or income to the payee.
- A capital gain exclusion of $250,000 (single) and $500,000 (married) exists for the sale of a principal residence, defined as where you lived for any two of the past five years. If after a separation, this rule tells us that the home must be sold within three years of departure for the exclusion to apply to the departing spouse.
- Marital status for tax filing purposes is set on the last day of the year--December 31. If you are divorced before December 31, you must file as a single taxpayer or head of household if you qualify. If you are still married on December 31, you can file jointly or separately, although the latter is not recommended since the total combined tax liability is greater than in the case of joint filing.
- If filing separately, the first to file's election of standard or itemized deductions requires the other filer to do the same. Ouch!
- Joint tax return = joint liability despite what your divorce agreement or Judgment says. The IRS "innocent spouse" exceptions are very limited.
- The custodial parent is entitled to claim the children as dependency exemptions unless otherwise agreed in writing.
- Attorneys fees related to a divorce are not generally deductible, whether your own or paid to your spouse's lawyer. Tax advice related to the divorce is deductible, as are fees paid to determine or collect alimony.
- If a person is obligated to pay child support and alimony but pays less than the monthly amount due, payments are first applied to satisfy the child support obligation (tax neutral) before alimony.
A tenth tip - Two assets with same value at the time of the settlement may have very different values when tax impacted. You have to be very conscious of the basis of assets and the appropriate tax rules. For example because of the capital gain exclusion on the martial residence, the house sold for a profit of $250,000 may be worth more than a stock portfolio sold for an equal gain.
In the end, you should discuss the tax impact of your divorce with your attorney and accountant.