Thanks to short days and frigid temperatures leaving us stuck indoors, February is the perfect time to begin thinking about preparing income tax returns. Those who have recently divorced or are now going through the process have additional issues to consider beyond what expenses can be deducted against income.
Here are six questions we often get asked this time of year.
1. Should we file jointly or separately?
Married couples usually choose to file jointly because the tax rate schedule for joint filers is lower than for couples who file separately. For tax purposes, you are considered married until you are divorced, yet one of the most common misconceptions is that legally separated couples may not continue to file joint income tax returns.
The answer to this question depends on when you concluded your divorce. If you were still legally separated on December 31st of the year in which you are filing, then you have a choice. You can agree to file jointly or married filing separately, or if you qualify, as head-of-household. For a list of requirements to be considered head of household, click here.
If you are divorced on the last day of the year, however, you may no longer file a joint income tax return, even if you were married for most of the year in question, and you must use the tax rate schedule of a single individual (or head-of-household).
2. Do I have to pay taxes on the support payments I receive?
Generally, support payments made by one spouse to another pursuant to a separation agreement or court order (known as alimony or maintenance) are deductible by the person making the payment and taxable for the person receiving them on their respective income tax returns. It is important for the spouse receiving alimony to plan for the fact that he or she will have to pay income taxes on this money and to consult with an accountant who can assist them in making estimated tax payments during the year. To see the IRS publication for more information on alimony, click here.
Child support is different. The person making the child support payment cannot deduct it, and the person receiving child support does not have to pay taxes on it.
3. Are assets distributed pursuant to divorce taxable?
Generally speaking the “equitable distribution” of assets is generally not taxable. In other words, there are no tax consequences in most transfers of property made by one spouse to the other as part of their settlement. For example, if the wife makes a payment to the husband as part of an agreement to buy out his interest in the marital residence, the husband will not be required to pay taxes on the amount he receives.
4. Will I pay a penalty if we divide our retirement accounts?
You may know that if you take an early distribution from your 401(k) or other retirement account you will be required to pay income taxes on that amount in addition to a penalty. This is not the case if that retirement account is divided in a divorce, pursuant to a court order known as a Qualified Domestic Relations Order (QDRO). A QDRO is a court order that allows the division of certain retirement assets without creating a taxable event. Thus, assets such as 401(k) accounts, 403(b) accounts and deferred compensation plan benefits can be divided as part of your divorce settlement without taxes being due or a penalty being imposed.
It should be noted that although QDROs do not apply to IRAs, the division of an IRA pursuant to a divorce is not considered a taxable transfer.
5. Who claims the kids?
Every taxpayer is entitled to a deduction (called an exemption) for himself and for each of his dependents. Until now, the question of these exemptions was probably not an issue since, in all likelihood, you have filed joint returns. For separating couples with children who have chosen to file separately, you must determine which of you will have the right to claim them as exemptions for income tax purposes. This also holds true for divorced couples, who, by necessity, must file separately. (There is no issue as to your own exemptions, as neither of you is entitled to claim the other as an exemption once you are separated.)
Generally speaking, the tax code provides that the parent with whom a child resides for more than half of the year (designated as the “custodial parent”) will be entitled to the exemption. The code then goes on to provide that the “non-custodial parent” will be entitled to claim the child as an exemption if the “custodial parent” signs a written declaration that he or she will not claim the child as a dependent for the year or years in question. In other words, the code gives you the ability to decide who will be entitled to claim your children as exemptions.
Some divorced couples decide to alternate who claims the children every year or few years. When there are two children, each parent can claim one, should the couple choose to do so.
6. What if we sell our home?
If you live in your primary residence for any two of the last five years you are eligible for a capital gains tax exclusion upon the sale of that residence. This exclusion is $250,000 for a single taxpayer and $500,000 for a married couple. If you move out of the house and your spouse has the right to live in it pursuant to a divorce or written separation agreement, your spouse’s residence in the house will be counted as your residence for purposes of calculating the two year residence requirement.
It is important to discuss all of the issues with your accountant before filing your returns and to inform him or her of the terms of your agreement.
Maren Cardillo Elbaum, JD, has been practicing for a decade, exclusively as an attorney-mediator at Divorce Mediation Professionals. She received training in divorce mediation at the Ackerman Institute for the Family in New York City. Maren dedicates her entire practice to helping couples find constructive resolutions for all of the issues pertaining to their separation and divorce and provides all related legal services.