The American poet Ogden Nash once wrote, “Indoors or out, no one relaxes in March, that month of wind and taxes.”
This month can be tumultuous on many fronts, and for women going through divorce, tax season can be particularly difficult –both emotionally and financially.
In an effort to calm at least part of the storm, here are answers to some of the tax questions most divorcing women must grapple with:
What is my tax filing status?
Your federal income tax filing status is set by your marital status on the last day of the tax year.
So, if you are still married on December 31st, then you are considered married for the entire year. Likewise, if you are divorced on December 31st, then you are considered divorced for the entire year.
That part is relatively easy, but if you are legally separated, things are more complicated. Here’s why:
The IRS usually follows state law for determining marital status. In other words, whether or not you are considered married or unmarried will depend upon complicated laws at both the state and federal level.
For example, according to tax law, an individual legally separated from his/her spouse under a decree of divorce or a decree of separate maintenance shall not be considered as married. But, not every state allows for a decree of separate maintenance; if you live in one of those states, you are still considered married until your divorce is final. You need to ask your attorney and/or tax advisor whether your current legal status meets the definition of a decree of separate maintenance. (Read more about this issue at my previous post Legal Separation or Divorce –Which is Better Financially?)
If you’re legally divorced, you must file as single or head of household. But, if you are still legally married, the IRS always allows you to file either jointly or separately. Tread carefully, however. For many, that choice can be a double-edged sword.
On the one hand, if you choose to file separately, you cannot be held responsible for your husband’s unpaid taxes. On the other hand, if you choose to file separately, you may miss out on key benefits and deductions. (A married filing jointly return is generally the most advantageous filing status for most people.)
Also, please note: Even if you choose to file separately this year, you will still be responsible for tax returns from prior years when you and your husband filed jointly.
What responsibility do I have if I sign a joint tax return?
Unless you take the appropriate precautions, signing a joint tax return can lead to trouble. Attorney Norman Heller, partner and matrimonial practice group leader, at Blank Rome in New York City, suggests you
- obtain a copy of the returns well before the filing deadline so your attorney and tax advisor can review them before you sign, and
- protect yourself with an indemnification agreement.
“If the husband wants the wife to sign joint tax returns when they are divorcing, she should try to obtain an indemnification agreement in which the husband agrees not only to pay the tax due on his and her income for the year, but also to hold her harmless should the IRS or state tax authority later determine more tax is owed,” Norman told me.
What happens if we file jointly, and there’s an overpayment (or underpayment) of taxes?
If there is an overpayment of tax, then your attorney should seek to have allocated to you some portion of the overpayment, or at least confirm in writing it’s a marital asset to be considered in the settlement or at trial.
If there’s an underpayment –because say, your husband takes aggressive tax positions or is in a cash business and doesn’t accurately record his income –you may not want to join in the joint returns since you can be held liable if the IRS comes after the parties for underpayment of tax.
“Innocent spouse treatment is not always available even if the wife wasn’t the one failing to report income or taking improper deductions,” Norman cautioned.
Can I file as “head of household?”
Filing as head of household will typically result in a lower tax bill than filing as single, but this designation has strict requirements. To qualify as head of household you must:
- maintain a household for your child (even if you do not claim them as a dependent)
- be unmarried at the end of the year or living apart from your spouse for more than six months
- provide more than half the cost of maintaining the household
- be a U.S. citizen or resident alien for the entire tax year
In addition, the household must be your home and generally must also be the main home of the qualifying dependent (i.e., they live there more than half the year).
People sometimes mistakenly believe that claiming a child as a dependent entitles them to file as head of household. This is not necessarily true. Even if you allow your ex-spouse to claim your child as a dependent, you can still file as head of household, provided you meet the requirements above.
Am I allowed to claim an exemption for my children?
The custodial parent is entitled to the exemption for children, although in some cases, this exemption can be traded to the non-custodial parent using IRS Form 8332.
The value of the exemption for children varies significantly depending on income, so talk to your accountant and divorce financial planner to see what would benefit you most.
Child-care credits are different than the exemption for children. Child-care credits cannot be traded; only the custodial parent can take them.
Are child support payments considered taxable income?
No. Child support is always tax-neutral, meaning it can’t affect your taxes in any way. Child support payments are not taxable income for the parent receiving the support. In addition, they are not tax deductible for the parent paying the support.
Are alimony payments considered taxable income?
Yes, most of the time. Alimony payments are almost always taxable income for the recipient –and they are tax deductible for the payor. However, the IRS is very strict regarding what qualifies for the alimony deduction. For example, if you and your husband continue to share a residence after the divorce, any alimony payments made during that time cannot be deducted. Also, the alimony payments deducted must be as outlined in a written separation or divorce agreement. (See a more detailed discussion in this earlier post, Seven Key Things Women Need to Know About the Tax Implications of Alimony Payments.)
In some cases, the husband and wife might agree that alimony will not be considered taxable income to the recipient and tax-deductible to the payor. If that language is included in the final divorce decree, then that income will not have to be declared by the recipient. Of course, the payor will not be allowed to deduct those payments, either.
Are assets transferred as part of my divorce settlement agreement taxable?
When assets are transferred as part of a divorce settlement agreement, the beneficiary doesn’t have to pay taxes on the transfer. However, if you decide to sell that property later, you will have to pay capital gains tax on all the appreciation before, as well as after, the transfer.
Capital gains taxes can be significant on big-ticket items, like your house. Here’s an example. Let’s assume you bought the home for $200,000, and it’s now worth $600,000. Your capital gain is $400,000. Subtract your $250,000 capital gains exclusion as a single person, and you’ll have to pay capital gains tax on $150,000. At the current capital gains tax rate of 15 percent, that amounts to a $22,500 tax bill! (And chances are pretty good that those tax rates will increase in the near future.) Capital gains tax is just one implication you need to consider when deciding whether or not to keep your house after divorce.
Is divorce tax advice deductible?
Possibly. Although you cannot deduct the cost of your divorce attorney and other expenses directly related to your divorce, you may be able to deduct certain fees and expenses for professionals who help you prepare your taxes, and what’s more, professional advice may be able to save you thousands of dollars in the taxes you owe.
One last word of caution
In many marriages, the husband simply signs the wife’s name to the returns, and she never actually signs them. As Norman points out, a woman who’s going through divorce should never take that chance.
“Once a divorce action is commenced or contemplated, the wife or her attorney should make it clear to the husband that he no longer has her consent to sign her name to anything involving tax matters,” he advised.
I have only brushed the surface in this short blog post. Even so, I’m sure this much is obvious: Tax law is incredibly complicated –and unfortunately, if you’re going through divorce, you’ll need to keep the short and long-term tax implications of any divorce settlement option top-of-mind. This is incredibly important and one of the many areas where an experienced divorce financial expert can make a significant difference in the final outcome of your divorce and your future financial security.
P.S. If you’re curious, the full quote from Ogden Nash is this:
Indoors or out, no one relaxes in March, that month of wind and taxes, the wind will presently disappear, the taxes last us all the year. ~Ogden Nash
I also got a chuckle from this one:
It’s income tax time again, Americans: time to gather up those receipts, get out those tax forms, sharpen up that pencil, and stab yourself in the aorta. ~Dave Barry
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