What is your (filing) status?
A Deep Dive into Divorce and Taxes
It’s not uncommon for me to meet with clients who tell me they have decided to hold off on filing for divorce because they want the child tax credit. However, delaying your divorce process could end up being costly in tax season. Most people do not realize that alimony is considered a supplemental income and is therefore taxable, but wait, that’s about to change. Starting in 2019 the new tax law will be in effect, which states, the paying party will no longer have the ability to deduct the payment as a write off and the receiving party will no longer have to pay taxes on the payment received. As tax season is in full swing, I wanted to share some things you should be considering when you file your tax return this year. If you are divorced or separated take some time to think about your Alimony, Child Support, Tax Deductions for Children, and your Filing Status.
First Things First, Filing Status
The government uses your filing status to calculate you correct tax, standard deduction, your qualifications for certain credits, and your filing requirements. Generally speaking, the rate of tax is going to increase according to the order listed below, beginning with the least taxed.
- Married Filing Jointly
- Single Head of Household
- Married Filing Separately
It seems obvious that the least taxed status would be the most desirable. However, if you are going through a divorce, there are some things you should really take some time to think about before you make a decision on how to file.
Married Filing Jointly: Are you legally allowed to file under Married Filing Jointly if you are separated and going through a divorce? According to the IRS, you are considered married and can file a joint tax return as long as you are still legally married as of December 31st for the year you are filing. This may not be the best idea though. Filing jointly means you could be held responsible for any problems with the tax return. Many clients tell me they were shocked and upset – they had no idea that anything was owed and that they would be held responsible. It’s so important to take the time to fully review and understand your tax return. You can always have your returns reviewed by a professional before you sign anything. If you find yourself in the out of options and realize that you are being held responsible, you can try to claim the “innocent spouse” principle. You will be given the opportunity to prove your point, and you might be able to escape liability. This should not be a part of your filing plan, but it is an option if you find that you in need of it.
Single Head of Household: If you meet the following criteria, you may be eligible for the Single Head of Household Filing.
- You were responsible for paying more than half of the household’s costs for the year.
- You have a child or other qualifying dependent living with you for more than half of the year.
- You were divorced by December 31st.
Single: As I stated earlier, your marital status as of December 31st for the year that you are filing determines your filing status. Even if you and your spouse lived together at any point during that year you will need to file as Single if you were divorced by that date. Since your filing status depends on your marital status as of December 31, if you were divorced by that date you would file as single taxpayer, regardless of whether or not you and your spouse lived together during any part of the year.
Married Filing Separately: You must file either Married Filing Jointly or Married Filing Separately if you were not divorced by December 31st for the year that you are filing. Unfortunately, Married Filing Separately is the highest taxed filing status; but as we also discussed, it might be worth it if you suspect you may held liable for your spouse’s taxed wages.
Second, Tax deductions for Children
I see many clients try to hold off on finalizing their divorce because they don’t want to lose the tax exemptions for their children, and often times, both spouses believe that they, individually, are entitled to the exemptions. A compromise would be ideal if the spouses could agree to split the exemptions. According to the IRS, the spouse who has custody of the children is the spouse that should have them as exemptions, but, if you use Form 8332, you can actually trade the exemptions back and forth.
It would make the most sense though, to allow the spouse with the higher income to take the tax deduction. I realize that this may upset the other spouse due to the lack of tax savings, so it may be best for the couple to consult with an expert who can determine what the exemptions should be to each spouse. It is my professional opinion that the spouse who can make the most use of the exemptions should be the one to take them, and should then recompense the other spouse. My mom always told me to pick my battles, this is definitely one that I would pick!
Third, Alimony and Child Support
There is so much confusion about child support, so please remember, it is not a taxable income to the receiving parent, and it is not a tax deduction for the paying parent. Alimony however, is, for now. If you don’t want to get a big surprise on April 15th, I highly recommend that you take the time to do a lifestyle analysis and that you budget for the taxes that alimony will incur. Being prepared may help soften the blow and if you are in the process of getting divorced, ask to have the new tax law language incorporated into your divorce agreement (if would be beneficial). Consider the taxes when you are discussing alimony. This tax law change can get complicated and will have an impact on not only Alimony but, in my opinion, how the parties come to the overall Marital Settlement Agreement.
Dealing with taxes and divorce is complicated on its own, dealing with taxes and divorce together can be painful. If you, like so many other, are struggling this tax season, I urge you to consult your Accountant, Lawyer, Certified Divorce Financial Analyst or Financial Advisor for further details.