Thursday, January 12, 2006

Taxes and Divorce

Taxes and divorce

Two incredibly unpleasant topics that, when combined, can be treacherous. Some tax pitfalls to look out for while navigating the maze of divorce:

Alimony

Are you receiving alimony? Generally, alimony is taxable to the recipient. Accordingly, you may be required to make estimated quarterly payments on the alimony you receive. Therefore, when budgeting, allow for your tax obligations. You may have to pay income taxes on that alimony you receive and that could put a serious dent in your cash flow.

Are you paying alimony? Generally, your payments could be deductible, resulting in a significant tax savings.

The Internal Revenue Code specifies the requirements that must be met in order for payments to be considered alimony. In other words, just because you call your payments alimony, does not mean the IRS will agree. Do not be surprised at tax time. Consult with a qualified accountant to make sure you understand the rules. Generally, the payments must be cash or check. (This means, if you pay the expenses for your spouse - ie pay the mortgage to the mortgage company - this would not be considered alimony). The document outlining your alimony obligation must be specific (See Internal Revenue Cod Section 71 (b)(1) and consult with a qualified accountant). You must live in separate households and file separate returns. The obligation must cease upon death.

Who claims the children?

Just because you are paying a large amount of child support does not mean you can claim your child as a dependent. In fact, generally, the custodial parent gets to claim the children. However, there are extremely specific rules. Additionally, a parent can release the right to claim the child as a dependent to the other parent using a specific IRS form .

Inasmuch as possible, cooperate with your spouse regarding who claims the children and have it included in the final agreement so everyone is clear. If you both claim the same children, you will end up tangling with the IRS and probably owing additionally interest and penalties.

What is your filing status?

If you live in Pennsylvania or New Jersey, generally, you are either married or divorce. If your divorce is still pending, you are considered married. To determine the appropriate filing status, first determine your marital status on the last day of the year (December 31). If your divorce was not final, then you are still married. Accordingly, you will have to decide whether to file jointly with your spouse (married filing jointly) or separately (married filing separately). In many cases, filing jointly results in the lowest tax burden but may be complicated if one or both of the parties owe taxes, there is a question as to one party’s income, one party under or overpaid their taxes throughout the year or one party does not have adequate information regarding the other party’s financial situation. If you sign a joint tax return with someone, you are vouching for whatever is on that return. Sometimes, to avoid liability, it may be prudent to file separately.

Filing separately usually results in a higher overall tax burden. Additionally, both parties must itemize deductions or both parties must take the standard deduction. This could result in an uneven tax burden. Consult with your accountant regarding the different filing options and discuss the matter with your attorney. Begin the discussion well before April 15 so any material issues can be ironed out before the filing deadline.

Sale of a Residence

Generally, a taxpayer can exclude up to $250,000 of gain on a residence from taxes. Married taxpayers, filing jointly can exclude up to $500,000 of gain. If the parties have lived in the residence long enough for it to have increased substantially in value, it may be prudent for the parties to sell it when they are still married and filing a joint tax return. If one party obtains the residence in the divorce and then sells it and incurs substantial gai, the tax bite could severely reduce the expected benefit. Consult with an account regarding this matter before deciding what to do with the marital residence.

Dependent Care Credit/Child Care Credit

If you incur work-related child care expenses, you may be eligible for a credit. Likewise, there is a tax credit available for a qualifying child under age 17. Consult with your accountant to determine your eligibility.

Do not make divorce more financially painful by being ill-prepared for the tax effects. As you negotiate the financial aspects of a divorce, consult with a qualified accountant as to the tax consequences along the way, so you can make informed decisions. This article is not meant to replace specific legal advice from your attorney and accountant.

1 comment:

WWW.TAX2020.COM said...

Good article, yea tax time is almost here