Going through a family law case is agonizing emotionally, taxing financially, complicated, confusing, and expensive, regardless of whether you and your spouse are getting along or at each other's throats, whether you have an attorney (or attorneys) or not, how much education you have, or how much money or how many children you have. It also can be difficult to get accurate and clear information, as it seems everyone has their own agenda in offering you their opinion. Your friends give you advice based on their experience, and each family law case is so different that it can be difficult if not dangerous to generalize. Attorneys give you information designed to convince you that you need their services (and to pay them lots of money). The media gives you information about celebrities with endless amounts of money. The internet gives you so much information that it's impossible to determine what's accurate.
This guide is designed to help you avoid pitfalls of the many tax consequences of getting a divorce. I believe that it is not always necessary to hire an attorney at exorbitant cost to complete your family law case successfully. This guide can be your starting place for saving as much as possible during your family law case. You CAN do it yourself, and I can help.
If you need more assistance than this guide, I can also help with hourly coaching. With just an hour or two of coaching, I can guide you through the maze of forms, documents, requirements, expectations, and knowledge required to emerge from your family law filing, hearing, judgment or trial with success. My fees are a small fraction of the cost of hiring an attorney, most often 5% or less of this cost. In today's economy, having the backing and experience of an experienced family law litigator on your side at the cost of an attorney consultation can be the difference between winning your case or losing everything.
Following are 40 Things You Don't Know about Divorce & Taxes that could Bankrupt You (in no particular order):
Get an estimate of what your tax bill (or refund!) will be. You can use this information to convince your spouse to file with you instead of filing separately (which will almost always cost you more).
TALK to your spouse about filing income taxes. It's better to decide in advance and work together than try to fix a mistake after the fact.
Don't wait to gather information, such as W-2s, I-9s, especially if you're the spouse without the information. You may need the court's help or to do discovery to obtain the information, and this can take several months.
Contact your accountant or the IRS for copies of prior returns. You can use Form 4506 on the IRS website.
Know your filing status options. You may file married filing jointly or married filing separately if you are legally married up to and on December 31 of the taxable year. You may file Head of Household if you lived physically apart prior to July 1 of the taxable year and you have a dependent (or a release from your spouse on Form 8332). You may ONLY file single if you are unmarried on the last day of the year.
Make sure you examine carefully any joint return you file. If you sign it blindly, you could be liable for any mistakes, inaccuracies, or falsehoods in the return.
If your spouse files separately, then you must as well. You cannot force your spouse to file jointly with you.
You need to divide equally any refund OR liability when filing jointly, regardless of whose income led to the refund or liability.
Support: Spousal support is taxable to the payee and deductible to the payor. Child support is neither. For spousal support to be deductible, it has to be pursuant to an order (cannot be an informal arrangement), you must not be living in the same house, it must be cash, and the order must specify that the support terminates upon the death of the recipient.
Consider the tax basis of the stock investments you divide to avoid an imbalance of assets do to the tax liability upon transfer of the investment.
Consider the tax consequences of what you plan to do with the house. If you plan to sell it, then the tax consequences could be beneficial or not. If you want to keep it, consider these consequences in making your buy-out arrangements.
If you move out of your house, then it still can be considered your principal residence for tax purposes. You have to have a written agreement with your spouse about this. This is permitted under the Taxpayer Relief Act of 1997.
You can't steal the tax refund. If you file jointly, the refund will be in both of your names.
If you have property tax arrears and one of you moves out, then you are still jointly (equally) liable for the arrears up to the time of the move out.
If you have child support arrears, any income tax refund can be intercepted to pay the arrears.
Spousal support can be NON-taxable if you specify this in the order or (written) agreement. You may want to consider this when: (a) the payor cannot use the deduction, for example when the payor's income is too low to take it or if the income comes from non-taxable sources, (b) the payor has sufficient deductions already, (c) the recipient is in a higher tax bracket than the payor, or (d) the recipient sells property to the payor after the divorce and does not want the proceeds to be considered income.
If you receive spousal support, it's not "free" money, but in fact taxable to you. Not only that, but you must provide your social security number to your spouse. If you fail to do so, the IRS can charge you $50.
If you PAY spousal support, keep detailed records of the payments in the event of a later dispute. Do NOT give cash, ever.
If you pay spousal support, you need your spouse's social security number (it must be provided or your spouse will be fined $50). In addition, you can deduct the payments even if you do not itemize your deductions.
The following may be considered spousal support: cash paid for the rent, mortgage, taxes, tuition, health expenses or medical expenses of the recipient, premium payments on term or whole life insurance (if the recipient of the spousal support is the owner of the policy), payments of attorney fees of the recipient, payment of the recipient's taxes, utilities or insurance (whether owned separately or jointly, however, if owned jointly, only one-half of these payments may be considered spousal support), payments after remarriage of the recipient (so long as the agreement specifies these payment shall continue), or some allotments from the military (you should see a military advisor for more details).
You can petition to the IRS for innocent spouse relief if your spouse files a return that is erroneous in terms of income or tax due.
You must decide who will claim your children as dependents for tax purposes. If the non-custodial parents wishes to claim the children, then that will result in higher child support. Since child support is already quite high in California, this can be a difficult decision. When the non-custodial parent claims the children, the custodial parent must release the exemption using IRS Form 8332.
These are some of the tax benefits available to parents: earned income credit, child care credit, medical expenses deduction, head of household filing status, dependency exemption, child tax credit, interest deduction for qualified education loans, and education IRAs. Considering these benefits is critical when making child custody, visitation, and support agreements. Your accountant can help you navigate through these various benefits.
Only a parent with primary physical custody can claim head of household tax filing status. If you share parenting time truly equally (a 50-50 split), then neither parent can claim head of household.
25. If parents are splitting parenting time equally such that neither can claim the head of household filing status, then there are a couple options. Parents can alternate each year having "51%" if there's one child, or they can each take one child as "51%" if there's two. If the children are divided for this tax purpose, keep in mind that (unless they are twins), one parent will lose the deduction once the child turns 18 and leaves the house. This can be planned for by alternating the head of household filing status once there's only one child left.
Fees paid to professionals for tax advice, is deductible from your income. You can deduct fees paid to collect spousal support if you are the recipient (note this is not true for the payor), so long as your attorney fees are not paid by your spouse. Either spouse can deduct any and all fees paid to professionals (such as attorneys, accountants, financial planners, and stockbrokers) for advice on tax issues arising out of your divorce. Note the billing must be itemized, showing how much was charged for tax issues.
In gathering tax information, you have several resources if you are waiting for information from your spouse. You can contact the bank and lenders for how much interest you have paid on a mortgage or student loan, a charity can tell you the amount of your donations, and you can contact your spouse's employer to verify your spouse's income.
Filing jointly during your divorce process is often the best way to maximize the money in you and your spouse's pockets. This is not always the case, however, and there are many considerations. These considerations include your tax rate, the deductions or credits you may lose, business losses, comparative benefits between filing jointly versus separately, and your liability for any of your spouse's dishonesty in the return. You should see an accountant to discuss these issues, and if you have a long-standing accountant who is close with your spouse, you may want to check with an independent accountant. The Family Law Coach works with a large network of professionals that can help you with your tax and other financial needs.
If your spouse settles an IRS tax bill (this is called an "offer in compromise" and is an agreement to pay less than the amount owed), then you could be liable for the unpaid balance. If you remarry, then even your new spouse could be liable for this amount.
You cannot force your spouse to file a joint tax return with you, regardless of the benefits offered to both of you. A good general rule is to file separately when there's any potential problem.
Voluntary spousal support payments are NOT deductible to the payor. "Voluntary" in this sense means not pursuant to a written court order. If you pay before the written order or after it terminates, then you cannot deduct the amounts paid.
If you have to order your tax returns from the IRS or your accountant, keep in mind that they will likely be sending the documents to the address they have on file. This might not be the address you live at, and if you do, you may be concerned about receiving your mail if your spouse still lives with you. Make sure you tell the IRS or your accountant where to send the documents where you can retrieve them safely, either at a friend or family member's house, or get yourself a post office box.
Taxes and retirement accounts. Get you or your spouse's retirement account appraised by a qualified actuary. This will give you the real amount of the retirement. For example, while the dollar amount in the retirement account may be the same as, say, the equity in the house, tax considerations may make this potential swap a windfall for one spouse (and a really bad deal for the other).
Dividing retirement benefits by Qualified Domestic Relations Order (QDRO): When your spouse has matured retirement benefits, generally you can divide them using a QDRO, and the plan will send you one check and your spouse one check when the time comes to distribute the funds. If this does not happen, then the retired spouse pays all the taxes on the retirement income. If the plan will not divide the benefits and send separate checks, then this is an issue you want to discuss in your marital settlement agreement to ensure the liabilities are divided equally.
For income tax purposes, any income you earn after your "date of separation" (listed on the Petition) is yours and yours alone. Between your date of marriage and date of separation, in the eyes of California law, all of your income was half yours and half your spouse's.
The tax consequences of each major financial step in your divorce must be taken into account, or you could be left with a hefty tax debt that you failed to plan for. Tax consequences are not always apparent on the face of a transaction, so you will need to work closely with an accountant (or a lawyer well-versed in tax issues) to ensure that you get a fair deal.
When you are dividing your property, make sure you know the tax basis of each asset. The tax basis on your assets will determine what you will pay in taxes when you dispose of the asset. You need to know this before you divide your property, not after.
Either parent may claim medical and dental expenses for the children that are above the designated percent of adjusted gross income.
When creating an order for child and spousal support, make sure you specify what amount is for child support and what amount is for spousal support. If the amounts are unallocated, then the entire amount is included in the income of the recipient and deductible by the payor.
When transferring your property in a divorce, the transfer does not trigger any tax consequences so long as the transfer takes place within one year of your divorce. This applies to real property, stocks, bonds, mutual funds, and any other property you owned jointly that one of you will now own alone.
In a summary dissolution, a hearing with the judge is typically not needed. A marriage of five years or less may be ended by summary dissolution, which is a simplified procedure to terminate a marriage in the state of California. With a summary dissolution, a joint petition is filed when 1) either spouse meets the standard residency requirement, 2) the marriage is irretrievably broken down due to irreconcilable differences, 3) the marriage is childless, 4) the wife is not pregnant, 5) neither spouse owns real estate, 6) there are no unpaid debts greater than $4,000, 7) the total value of community property is less than $25,000, 8) neither spouse has separate property (excluding cars and loans) of greater than $25,000, 9) the spouses have reached an agreement regarding the division and distributions of assets and liabilities, 10) both waive their rights to maintenance and appeal; 11) both have read a brochure about summary dissolution and 12) both desire to end the marriage.
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