Tax Planning for the divorcing and newly divorced
NEW YORK (Reuters) - Divorce and taxes: Two topics you'd probably rather not think about. But if you're going through a divorce, or recently finalized one, there are going to be tax issues that crop up. After all, your financial lives have been entwined for years, and especially if you have young kids, they're going to continue to be that way for some time.
"When I was in private practice in San Francisco, I had several divorce lawyers who would call with tax questions, and it was always, ‘I have a divorce that's getting contentious and ugly….,'" says CBIZ MHM's Bill Smith, managing director of the CBIZ national tax office. Beyond the ugliness, he says, "there are fundamental questions about how to write the agreement so that alimony is tax deductible, and there are a lot of issues with sales of assets that occur during a divorce."
Once you've dealt with the emotional fallout of the divorce, here's how to think about the tax issues that may come up.
1. Alimony and child support.
Generally, spousal support is taxable to the person who receives it and deductible to the person who pays it, while child support is neither taxed nor deducted, says Monica Mazzei, a family law attorney at Sideman & Bancroft in San Francisco. "Some people do not realize they have to include spousal support as income and they get taxed on it. You can agree otherwise," she says. What Mazzei means is this: According to the tax rules, payments to your ex aren't considered alimony if the divorce decree says that they're not.
The result is that, especially for the first tax return after a divorce, you may need to actually look back at the settlement agreement to see what it says. "People call me and say, ‘I'm at my tax preparer's office now, is my spousal support taxable?' I'll have to go to my computer and look it up," Mazzei says. "Most people when they're done with the divorce want to forget the details and the process."
If you're the one paying alimony, you don't need to itemize to claim the deduction, but can simply take it on Form 1040. If you're the one receiving it, you'll likewise report it on Form 1040. And note: If you do receive alimony, you may have to pay estimated taxes.
2. The dependency exemption.
Generally, whichever parent has the most custodial time with the kids takes the exemption. But the settlement agreement can stipulate something else — perhaps that the mom takes it in even years, and the dad takes it in odd years. These are both tax issues to pay attention to while negotiating the divorce, and to remember for tax time in the future. If the non-custodial parent (that is, the one who has less days with kid, even if it's just marginally less) claims the children as dependents, at tax time, he or she will file Form 8332, a release of the exemption signed by the custodial parent.
3. Division or property.
The thorny issues of who gets what gives rise to equally complex tax issues that you'll want a good accountant to work on with you. In general, for tax purposes, property acquired in a divorce is considered to be a "gift," and non-taxable for income tax purposes. The cost basis of that property — that is, its value for figuring any taxable gains at whatever point you sell — is the same as your ex-spouse's. If what's at issue is an income-producing asset — a rental property, say, or a stock portfolio — any taxable gains or losses from that asset are divided at the date of transfer.
4. Writing off the portion of fees spent on tax advice.
While you can't write off divorce attorneys fees generally, you can deduct the portion of those fees — whether to lawyers, appraisers, actuaries or accountants — that went for tax advice or for help in getting alimony. Those fees get lumped into the miscellaneous itemized deduction (which can only be taken after it exceeds 2 percent of adjusted gross income) and are reported on Schedule A. "Family lawyers are not going to be happy I mentioned this because doing it is so tedious," Mazzei says. "Hardly anyone ever asks."
5. Determining your filing status.
For tax purposes, if you haven't legally divorced by year-end, you're married for tax purposes. That can lead to some strategizing for those whose divorces are nearing conclusion in the fall. While some people may want to just get the darned thing done already, there may be financial benefits to waiting for the new year and filing jointly one last time—if you're still thinking rationally. More complex: If your marriage was annulled, then you're considered unmarried for tax purposes even if you filed joint returns for previous years, and you need to go back and amend them with Form 1040X.
(The author is a Reuters contributor. For more, see blogs.reuters.com/amy-feldman/)
( Editing by Lauren Young; Desking by Andrew Hay)