Sunday, September 23, 2012

Taxes and Divorce

UPDATED for the Tump/GOP Tax Law
UPDATED December 2018

If you like the blog, buy my book: Everyday Taxes


Practical Tax Guide for Divorce

This document represents the author's opinion and interpretation
of current tax law and does not necessarily represent the interpretation or
opinion of H&R Block or the Internal Revenue Service

Tax issues for divorcing couples has become more complex every year, and recent tax law changes have made it even more imperative that good preparation and advice be given during and after a divorce is final.  This guide is designed to help a divorce lawyer give the best possible advice to their clients, as well as prevent them from making some common tax mistakes.

Tax planning begins at the moment of separation (or before if you haven't told your partner).  Many individuals are unprepared for the effect that separation has on their tax situation.  Most only discover the difficulty when they go to file their taxes and discover that they can't file as Single.  Keep in mind that marital status is determined on 12/31 of the tax year.  If you are still married and living together on this date, all the stuff about custodial vs. non custodial parent doesn't apply.  Children are claimed via standard tie-breaker rules (# nights, then AGI).

Couples who are still married generally can only file Married Filing Jointly (MFJ) or Married Filing Separately (MFS).  MFS has significant disadvantages due to disallowed deductions and lower income thresholds.  It is rarely a good way to file.  In order to avoid this quandary, you have limited options: (listed in general order of preference)

I..  The custodial parent may be able to file Head of Household if they meet all the following requirements: (The non-custodial parent would be MFS unless they had a different child)
   A. You are unmarried or “considered unmarried” on the last day of the year.
        1. You are considered unmarried on the last day of the tax year if you meet all the following tests:
             a. You file a separate return.
             b. You paid more than half the cost of keeping up your home for the tax year.
             c. Your spouse did not live in your home during the last 6 months of the tax year.
             d. Your home was the main home of your child, stepchild, or foster child for more than half the year.
        2. You paid more than half the cost of keeping up a home for the year.
        3. A “qualifying person” lived with you in the home for more than half the year (except for temporary absences, such as school). However, if the “qualifying person” is your dependent parent, he or she does not have to live with you.
        4. You must be able to claim an exemption for the child. However, you meet this test if you cannot claim the exemption only because the noncustodial parent can claim the child using the rule for divorced or separated parents (or parents who live apart)
Note: HOH has new due diligence requirements for the 2018 tax year, so a preparer will ask tougher questions, and the IRS is more likely to question this status - make sure you have your ducks in a row.

II.   They may file Single if they obtain a divorce or separation agreement prior to 12/31 of the tax year.  I understand that SC does not do formal separations but I believe you can sign an agreement and file it with the court - this would satisfy the requirement. State law determines who is divorced or legally separated so talk to your lawyer about it.

III. They may file MFJ with their spouse and divide the refund. Talk to your lawyer about the division since state law may require certain things. Also, a good tax professional can help you understand the various rationales for how to divide it.

Once divorced or separated there are a number of issues to consider.  I'll start with the biggie: 
Children. 

Who can Claim the Child:

The IRS uses many of the same terms that lawyers and laymen use, but they don't mean the same thing.  Many people believe that custody as granted in a divorce decree is custody for taxes.  It is not.  The IRS defines custodial parent as the parent the child spent the most nights with during the tax year.  In the event of a tie, the parent with the higher Adjusted Gross Income is the custodial parent.  Nights are counted based on spending with the parent or in the parent's home.  If the child is not with either, the night counts for the parent who would normally have the child in their home.  This could happen for sleepovers or when the parent is military deployed, so the deployed individuals family takes the child.

Again, the IRS does not care what the divorce decree says.  Another important point is that a divorce decree cannot force a parent to grant the exemption to the non-custodial parent (except decrees before 1985.)  After 1984 and before 2009, a divorce decree that gives the claim to the non-custodial parent WITHOUT ANY ADDITIONAL REQUIREMENTS (such as up to date on child support) and states that the non-custodial parent can claim the child (and that the custodial parent will not) for specified years may be used for the non-custodial parent to claim the exemption.  The decree must be signed by the custodial parent (judge signature not required.)  This is an important point.  Post 1985, only the custodial parent can release an exemption - the divorce decree was simply the method by which it was proved.  It can be revoked, by providing (or good faith attempt to provide) in writing to the non-custodial parent that the custodial parent is releasing the exemption.  This notice and proof of attempted delivery must be enclosed with the tax return.  Post 2008, ONLY a signed IRS form 8332 or similar statement may release the exemption.  A judge can require you to do this, but the IRS will not enforce this order. If your spouse fails to provide it as ordered, they have to go back to the judge.

My recommendation to divorce lawyers is that if they are representing the non-custodial parent that they get an 8332 form signed specifying all years that their client may claim the child.  It is still revocable, but this is still the best way.  If I was representing the custodial parent, I would recommend they not provide the form upfront, rather that they provide it each year.  Obviously the tenor of the divorce will affect this decision.

The non-custodial parent will have to attach this form to their return (or mail in with IRS form 8453 if electronically filing) each year they claim the child.

Who can Claim What for the Child:

This is vitally important and regularly done wrong.  When the non-custodial parent is claiming the child, it is vital that BOTH parents file the child correctly.  They are "splitting" benefits.  As a general rule, the non-custodial parent only gets the exemption and the Child Tax Credit.  The custodial parent is the ONLY one who can get Earned Income Credit (EIC) and the Daycare Credit, as well as file as Head of Household.  Even when the non-custodial parent makes too much money to get EIC, they must still file as the non-custodial parent.  No divorce decree, judge or lawyer can change this.  Other items are less obvious...

Medical Expenses go to who paid them
Education Credits go with the exemption (custodial unless 8332 signed.)

It is CRITICAL that you pay attention to questions asked by software about where the child lives, how long, divorce etc. Failing to do this will cause a lot of trouble for both of you.

Child Support and Alimony:

Child Support is never taxed or deducted. For divorces finalized in 2018 and before, Alimony is generally taxed to the recipient and deducted by the payer.  If Alimony and or Child Support is not up to date, payments are presumed to be Child Support first, and then Alimony.  Alimony has special tax requirements and recapture rules, so don't assume that just because the divorce decree calls it alimony that it qualifies to be deducted. Starting with divorces finalized in 2019 and later, Alimony is not deducted by the payer, nor taxed to the recipient. WARNING: It's the date of the DIVORCE that matters, not the date of the payment. All divorces finalized in 2018 and before remain unaffected by the new law.

Final Points: Make sure you have your children's and ex (or soon to be ex) spouses SSN and birthday - you will need them for taxes!

If you have any questions, feel free to contact me, Kirk Taylor, at taxadvisor@email.com. 

Feel free to share this information with anyone who can use it.


Form 8332 (Release of Exemption):                                       
Pub 504 (Tax Guide for Divorced/Separated):                       
Pub 501 (Exemptions etc.):                                                     
Pub 17 (Your Federal Income Tax):                                       

No comments:

Post a Comment

I will try to answer questions, though if they are complicated, email me at taxadvisor@email.com. Consider buying one of my books to thank me for my answers. Spam comments will be deleted. No links unless they are pertinent to the question asked. If you want cross promotion - ask.