Divorce and Taxes
Divorce is one of the most stressful times of a person’s life – emotionally and financially. Divorce can have a major impact on your taxes with the federal government and the state of California wanting their share, so having some basic knowledge as to what can and can’t be taxed will save you time and money during and after this difficult process. Below are some things to be aware of as you are going through a divorce:
You are required to let the IRS know your legal marital status as of December 31. If your divorce papers have not been finalized by December 31st, you must let the IRS know that you are married for that year.
You can file your tax return as “Married Filing Jointly” or “Married Filing Separately”. Married Filing Jointly spouses do not need to be living together to file jointly. The advantage of this option is you can take more credits and deductions such as Earned Income Credit, Child and Dependent Care Credit, education credits or deduct interest on student loans. The disadvantage is you are liable with your spouse for all taxes due including penalties and interest, even if you didn’t earn the underlying income or have knowledge of the underlying income.
Spouses who file Married Filing Separately main advantage is only being responsible for their own tax return. The disadvantages are that you cannot claim some credits and deductions and you both must either itemize your deductions or you both must take the standard deductions. You are not allowed to mix and match.
Head of Household
If you meet the requirements for “head of household”, you do not have the joint liability that comes with “married filing jointly” and the exemptions, credits and deductions are not as limited as when you file “married filing separately”. If you qualify, you can itemize your deductions or take the standard deduction. To qualify you have to have paid more than fifty percent of the upkeep of home, your home was the main residence for your child(ren), and you can claim an exemption for your child(ren).
If your final decree of dissolution of marriage or legal separation was entered by or even on December 31, the IRS deems you unmarried for the entire tax year. This is a very important step to consider when figuring out the tax implications of your divorce.
Child Dependency Exemption
Only one parent can claim the dependency tax exemption. This also entitles the parent to the $1000 per child tax credit for children under the age of 17 who do not earn an income. If a custodial parent has been named on the divorce decree than this is a straightforward exemption. If it doesn’t, than it is usually the parent who has the child the most during the year, or one parent signs a waiver giving up their exemption.
Alimony, Maintenance and Child Support
Payments between divorced spouses under a divorce decree fall into different categories. Alimony is deductible by the person who makes the payment and is counted as income for the person who receives it.
Child Support is not deductible nor counted as income. Be sure that in the divorce decree, it is described as such or it could be taxed.
As part of your divorce settlement, a spouse may be entitled to part of the other spouse’s IRAs or retirement accounts. You may also be able to roll 401(k) money into your own IRA.
For property transfers to be considered part of a divorce proceeding, the transfer must take place within a year of the date the marriage legally ended, unless it was otherwise specified, and if that is the case you have up to six years to make the transfer. Generally, neither spouse has any tax consequences from receiving or giving up property in a divorce. However, if you do later sell the property you received in a divorce, you will be required to pay taxes on it based on the original tax basis.
California law defines community property as any asset acquired or income earned by a married person while living with a spouse. Separate property is defined as anything acquired by a spouse before the marriage, during the marriage by gift, devise, or bequest, and after the parties separate. The law requires that the community estate be divided equally if there is no written agreement requiring a particular division of property. This means that from the total fair market value of the community assets, the joint obligations of the parties are subtracted, yielding the net community estate. Unless agreed otherwise, each spouse must receive half of the net community estate.