Taxes: Divorce & Children

In the words of The Beatles, “ ‘Cause I’m the Taxman…,” and because it’s almost the filing deadline (April 16 this year), the Taxman is here.  Marital and family status, of course, has a big impact on your taxes. So, here are some important rules everyone needs to know if they are going through a divorce, are already divorced or have children with someone to whom they are not married.

Separate Tax Returns?

If a couple is not yet divorced and therefore still legally married, there are two options for tax filing status:  (1) Married Filing Joint; or (2) Married Filing Separate (with or without Head of Household status).  You should undergo a careful review of your circumstances with a family law attorney and a CPA to understand the risks and rewards of each tax filing status.  While typically the most financially advantageous status is Married Filing Joint, consider filing a separate tax return if there is any doubt about your spouse’s ability or intent to file an accurate tax return. Otherwise, by signing a joint return you are responsible for all taxes and penalties, if any, associated with the tax return.  Also, if there is any doubt about your spouse’s income or deductions, filing a joint tax return while a divorce is pending may limit your ability in the divorce proceeding to claim the figures on the return are not accurate.  In essence, signing the joint return may indicate your tacit acceptance of the information, thereby making it difficult if not impossible to take a contrary position in the divorce proceeding.

Spousal Support.

A spouse (or former spouse) receiving spousal support pursuant to a written agreement or court order must pay taxes on this money; the spouse (or former spouse) paying spousal support receives a tax deduction.  Depending on which applies to you, be sure that it is properly documented on your return.

Dependency Exemption.

If children are involved, only one parent in a given tax year can claim a child as a dependent. Generally, a parent who has the custodial responsibility of the child more than 50% of the time automatically receives the Dependency Exemption.  The Dependency Exemption can be “released” to the parent with less than 50% custody, but a specific form must be filled out by the “releasing” parent and the form must then be attached to the other parent’s tax return to document for the IRS that the release occurred.

Head of Household.

Unlike the Dependency Exemption, the Head of Household status cannot be “released” or otherwise transferred between parents.  Rather, there is a long list of requirements set forth by the IRS to determine whether or not a parent qualifies for this status.  Either a parent qualifies, or they don’t.  Careful review of these rules with a CPA is required.  In future years child custody may be structured to insure the parents can equally benefit from this tax filing status (not necessarily in the same tax year, however). But when filing taxes for a year that is completed, the past is the past and Head of Household status cannot be changed retroactively.  If strategic tax planning on this issue was not done as part of your family law case,  then a CPA must determine, based upon the prior calendar year (which is the current tax year), whether or not a parent qualifies for Head of Household status.

Attorney and Other Expert Fees.

Generally, fees charged by attorneys, accountants, appraisers and other experts in connection with marriage dissolution, child custody and similar family law disputes are not deductible by either party because they are considered personal expenses.  However, these expenses are deductible if they are incurred to obtain taxable income, such as for establishing taxable spousal support, for a modification proceeding or negotiation to increase spousal support, or for resisting a decrease in spousal support.  Other examples of fees incurred to obtain taxable income are:

  • Cost of obtaining an interest in the other spouse’s pension or profit-sharing plan (including the preparation of a Qualified Domestic Relations Order which divides the retirement plan), since distributions from the plan will be taxable when received;
  • Cost of obtaining other assets that will be taxable when received (such as a portion of an author’s royalties in a community property work);
  • Costs of properly structuring a property division to produce desired tax effects;
  • Costs to determine the adjusted basis of assets which are to be distributed in the divorce settlement;
  • Costs of planning an alimony trust or annuity agreement;
  • Costs of estate planning which relate to determining estate and gift tax consequences on relevant property;
  • Costs to prepare a written agreement to assure deductible support payments;
  • Costs for maximizing the deductible portion of spousal support or for minimizing the taxable portion of spousal support;
  • Costs of allocating Dependency Exemptions;
  • Costs to assure that either spouse or both spouses can secure rollover treatment for the sale of the residence in connection with the divorce; and
  • Costs of obtaining advice about the tax consequences of a divorce or separation instrument.

These are complex financial concerns which require the advice and guidance of an accountant to determine how they affect your particular situation.  Every party to a divorce should seek advice from an accountant and a family law attorney about the tax consequences that divorce and children bring.  Doing so can make an otherwise difficult tax season less trying.