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 DIVORCE: TAX AND FINANCE ISSUES
Prepared by Janice Page, CPA
Revised June 2003

Maintenance (Alimony)

1-Maintenance payments are taxable to the recipient and deductible by the payer. These are payments made under a divorce or separation instrument.  No minimum payment period is required.

2-Temporary maintenance payments made while the divorce is pending and pursuant to a court order are taxable. 

3-Maintenance payments must be paid in cash or by check.  If noted in the agreement, maintenance may include payments to third parties on your behalf such as: medical expenses, housing costs (rent, utilities, etc.) taxes, tuition, life insurance, providing these are your obligations. (NOTE: If your ex-spouse pays your rent, but the lease is in his name, it will not be taxable maintenance since the obligation is his.) 

4-Maintenance is not: child support, noncash property settlements, transfers of property, use of property, payments to keep up the payer's property, voluntary payments not required by the agreement. 

5-If you must continue to make payments for any period after your spouse's death, none of the payments made before or after the death is maintenance.  

 

Child Support 

1-Child support payments are not taxable to the recipient and not deductible by the payer.  A payment is fixed as child support under your divorce or separation instrument.  A payment will be treated as child support if the payment is reduced on the happening of a contingency relating to the child (e.g. reaching a specific age, dying, marrying, etc.) or at a time that can be clearly associated with the contingency. 

2-If both child support payments and maintenance are awarded:

a) Make sure the agreement clearly states how much is for maintenance and how much is for child support; otherwise, the IRS could make its own allocation which may be unfavorable to you. 

b) If only partial payment is received, the IRS first applies the payment to support and the balance to maintenance. 

3-According to New York State's Child Support Standards Act, child support is calculated as follows: Income less FICA taxes and local taxes (e.g. NYC and Yonkers) times 17% for one child, 25% for two children and 29% for three children.    

4-Costs for education (after-school programs, tuition, books, musical instruments, computers, etc.) or medical care can be divided according to each parent's pro-rata income.  For example: If the father earns twice as much as the mother, he should pay twice as much for these expenditures than the mother. 

 

Property Settlements 

1-Transfers of property pursuant to a separation or divorce agreement or annulment generally are not subject to income tax if they occur within one year after the marriage ends.  These transfers are treated as if acquired by gift for income tax purposes.  However, this does not apply if your spouse or former spouse is a nonresident alien. 

2-A transfer of property can still be tax-free if the transfer occurs later than one year but up to six years, providing that it is related to the cessation of the marriage and it is authorized by a divorce decree.  This circumstance could occur if there were significant financial reasons for not performing the transfer sooner, such as it would adversely affect an ongoing business. 

3-A transfer of property in exchange for the release of marital rights must be reported on a gift tax return for the calendar year the transfer was made.   

4-Property settlements do not include services. 

5-Your basis in the property received is the same as the transferor's basis. (For example: Your spouse transfers to you 100 shares of IBM that he bought in 1986 for $100 per share for a total cost to him of $10,000.  On the date of transfer, the 100 shares of IBM were worth $11,000.  Your basis in the stock is $10,000, the same as when your spouse owned it.  If you sold the stock that same day, you would have a taxable gain of $1,000.) 

 

Tax Exemption for Dependents 

1-Beginning in 1998, there are various credits available for the parent who takes the dependency exemption for the child.  It is now very important to reconsider giving up this exemption since you may also be giving up significant tax credits too.  

2-In situations of divorce or separation, the parent who has custody of the child for the greater part of the year is generally treated as the parent who gave more than half of the child's support; and therefore, can take the dependency exemption on the tax return. 

3-The noncustodial parent can take the dependency exemption if the custodial parent agrees not to claim the child's exemption.  But, the noncustodial parent must attach IRS form 8332 to his or her tax return. 

4-If you have joint custody of your children with your ex-spouse, or legally separated spouse, and share the support costs equally, then neither of you gave more than half of the child's support; and therefore, neither of you can take the dependency exemption.  To get around this issue you and your ex-spouse can take turns claiming the exemption by filing IRS form #2120-Multiple Support Declaration.

 

Filing Status 

1-Joint Return:   

a) As long as you are still married, you and your spouse may file a joint tax return. Filing joint usually incurs a lower tax liability than filing "married, but separate" returns.  However, if you file joint, both you and your spouse are liable for any tax due regardless of what your agreement states and regardless of who earned the money.

b) Innocent spouse exception: You may not have to pay the additional tax, interest and penalties if you can prove that you did not know and had no reason to know about any tax understatement; and, that it would be unfair, under all the facts and circumstances, to hold you liable.  There have been numerous changes to the “innocent spouse” rules.  If you are being asked to pay tax liabilities on income earned by your spouse, you should consult with a tax advisor before signing any contracts with any government entity. 

c) Injured spouse: If you are due a refund but have not paid certain debts, all or part of your refund may be used to pay the past-due amount.  The debts that may be paid from your refund are child and spousal support payments and federal debts such as student loans.  You can prevent your share of a tax refund on a joint return from being applied to a debt owed by your spouse by attaching a completed Form 8379, "Injured Spouse Claim and Allocation", to your return.  Write "Injured Spouse" in the upper left corner of Form 1040.  You are an "Injured Spouse" if:  you are not obligated to pay the debt; you had income that was reported on the tax return; you had tax withheld or made estimated tax payments that was reported on the return; and you had an overpayment that will be (or was) applied to your spouse's debt. 

 

2-Separate Returns: 

a) If you and your spouse file separate returns, you should each report only your own income, exemptions, deductions and credits on your individual return.  If you and your spouse file separate returns and one of you itemizes deductions, the other spouse will not qualify for the standard deduction and therefore must also itemize his/her tax return. 

b) If you and your spouse file separately, you each are responsible only for the tax due on your own return. 

c) Separate returns most often cause you to pay higher taxes than joint returns. If you file separately, you cannot take the credit for child and dependent care expenses and you are limited in the IRA deductions you can take. 

d) If you and your spouse file separate returns, you can change to a joint return any time within 3 years from the due date of the separate returns. (However, if you filed joint, you cannot then change to separate returns at a later date.) 

e) If you do not have a separation agreement and you do not have a dependent child, and even if you did not live together at all during the year, you cannot file as single, but must file as "married, filing separate" or "married joint". 

 

3-Head of Household (HOH): 

a) You may file as "Head of Household" if you were unmarried or were considered unmarried on the last day of the year and you paid more than half the cost for more than half the year of keeping up a home for you and your unmarried child, grandchild, stepchild or adopted child. 

b) If you are still married, you are considered unmarried if you paid more than half the cost of keeping up your home for the tax year; your spouse did not live in your home during the last 6 months of the year and your home was, for more than half the

year, the main home of your child, stepchild, adopted child or foster child whom you can claim as a dependent.

c) You are keeping up a home only if you pay more than half the cost of its upkeep.  This includes such costs as rent, mortgage interest, taxes, insurance on the home, repairs, utilities and food eaten in the home. 

d) If you qualify, it is advantageous to file as "head of household" since the tax rates are lower than that on a single, or married filing separate return; the standard deduction is also higher than that allowed on a single or married filing separate return.

e) The custodial parent can still file as HOH while not taking the dependency exemption.  The non-custodial parent who takes the exemption (providing form #8332 is filed) must file as "single". 

 

4-Single: 

a) You may file as single, if you have no dependents, providing that on the last day

of the year you have a separation agreement or are divorced.  If you have neither, you must file as "married, filing separate".                                       

b) If your marriage is annulled, you are required to file amended tax returns, filing as single, for the last three years that you filed joint tax returns.  This action can most often qualify you for a tax refund since the tax liability is usually higher for married couples than single people.

 

Tax Deductions 

1-Normally, legal fees are not deductible for the purpose of obtaining a divorce. However, the attempt to procure alimony and tax related advice is deductible.  The IRS will allow legal fees to be deductible if your lawyer states in a letter to you the percentage of the time she spent advising you on the issues of alimony and tax advice. Use that percentage to determine the amount of your tax-deductible legal fees. 

2-In addition you can include fees you pay to appraisers, actuaries and accountants for services in determining your correct tax or helping to get alimony.