In addition to the many challenges presented by divorce, you must work to untangle your financial situation. And following a complicated divorce, tax issues become more complex than they were when you filed as a couple. Fortunately, the IRS has a comprehensive list of circumstances for divorced and separated individuals in its Publication 504.
The terms of your divorce are unique to you, so work closely with your accountant, especially the first time you file taxes after your divorce is finalized. This can help you figure out your filing status and possible tax deductions and credits.
Your Filing Status After Divorce
While legal issues might bring discussions down to the level of cold, harsh language and a complicated contract, the IRS doesn’t leave room to take things personally – its basic rules are firm and fairly simple.
Your tax filing status is determined by the status of your marriage on the last day of the year. If your divorce is final anytime before December 31 (a final decree of divorce or separate maintenance), you can file as single or head of household for that year. If your divorce proceedings and paperwork aren’t complete by December 31 by the last day of your tax year, the IRS still generally considers you married and you must file accordingly. There are, however, exceptions to this rule. You are considered unmarried on the last day of the tax year if you meet all the following tests:
- If you paid more than half the expense of keeping up your home for the tax year in question.
- If your spouse didn’t live in your home during the last six months of the tax year. (See Temporary Absences for details)
- If your home was the main home of either your child, foster child, or stepchild for more than half of the year. (See Qualifying Person)
- You are able to claim an exemption for the child. (See Special rule for divorced or separated parents (or parents who live apart) and the general rules for claiming an exemption for a dependent in Table 3).
If you don’t live with your spouse, you may be considered unmarried and may be able to file as head of household (see Head of Household). You should also check with your state to determine if you are considered legally separated, which makes you unmarried in the eyes of the IRS.
One-Sided Joint Filing
If your spouse wants to file a joint return, you don’t necessarily have to agree, but if you don’t file an objection, or your own return first, then the joint return is valid even without your signature. If your ex is going to file a joint return and you want your own independent return on the record, file under the status of married filing separately as soon as possible. If you expect this issue to be a problem, discuss it immediately with your former spouse, and a lawyer.
If your former spouse files a return that you discover to be fraudulent, you can apply for “innocent spouse relief” on the grounds that you did not know about or encourage these actions. This should hopefully keep you from incurring any penalties. You can also apply for innocent spouse relief if your former spouse has racked up a large tax bill that you didn’t contribute to.
Filing Status and Selling Your Home
If you’re still legally married and decide to sell your home, then married filing jointly status allows you to exclude the first $500,000 of profit on the home from income taxes, provided you used the home as your main residence for at least two of the five years prior to selling. If you choose the status of married filing separately, or if you’re legally divorced when the sale goes through, you and your ex-spouse can each exclude $250,000. If you still have profit beyond the maximum, you must pay the long-term capital gains tax rate.
Child Support and Alimony
If you have children and are obligated to pay child support, it’s important to know that child support is “tax neutral.” Paying for child support is not tax-deductible, and receiving child support payments doesn’t raise tax liability.
Alimony, on the other hand, is taxable income. Even if child support and alimony payments are covered in one monthly payment, the IRS considers the alimony portion of payments to be taxable income. If you’re paying alimony, keep track of the total each month, as you can deduct it. On the other hand, if you’re receiving alimony, make sure you don’t exclude it when you calculate your income for tax purposes.
Furthermore, if you receive alimony and don’t have a job that withholds taxes, you might need to make estimated tax payments so you don’t fall behind on your taxes due. Because of the quirks of tax obligations after divorce, many couples negotiate the levels of child support and alimony to better leverage tax liability.
If you are ordered by the court to make payments on the mortgage of a jointly owned home, but you no longer live in the home, you can deduct a portion of your payments as alimony. Your former spouse must claim it as income, and you can also take a tax deduction for the appropriate percentage of the mortgage interest and real estate taxes. Check with the IRS or your accountant for details.
Tax Benefits for the Custodial Parent
After a divorce, the parent with whom the children live most of the time is the custodial parent, and usually ends up with the largest burden of expenses. However, the custodial parent qualifies for a few tax breaks, which can help lower tax expenses even before the divorce process is complete.
1. Head of Household Filing Status
If you were married for a long time, you might think you automatically have to go back to filing as single. That’s not the case. If you can claim a qualifying dependent and meet the requirements, you can reduce your taxable income significantly by filing as head of household. The standard deduction is higher, and more of your income will fall into lower income tax brackets.
2. Earned Income Tax Credit
If you were the lower-earning spouse and are now taking care of the children, you might be eligible for the Earned Income Tax Credit. For higher-income households, the credit isn’t as generous (or even available). However, if you qualify to take this credit, it can significantly reduce your tax liability.
The following 2015 income limits refer to earned income and adjusted gross income, whichever is larger:
- $47,747 ($53,267 married filing jointly) with three or more qualifying children
- $44,454 ($49,974 married filing jointly) with two qualifying children
- $39,131 ($44,651 married filing jointly) with one qualifying child
- $14,820 ($20,330 married filing jointly) with no qualifying children
And for next year’s tax preparation, these are the 2016 income limits:
- $47,955 ($53,505 married filing jointly) with three or more qualifying children
- $44,648 ($50,198 married filing jointly) with two qualifying children
- $39,296 ($44,846 married filing jointly) with one qualifying child
- $14,880 ($20,430 married filing jointly) with no qualifying children
The maximum tax credits for the 2015 tax year are as follows:
- $6,242 with three or more qualifying children
- $5,548 with two qualifying children
- $3,359 with one qualifying child
- $503 with no qualifying children
And the maximum tax credits for the 2016 tax year:
- $6,269 with three or more qualifying children
- $5,572 with two qualifying children
- $3,373 with one qualifying child
- $506 with no qualifying children
Again, since child support is not considered earned income, it won’t affect your eligibility for the Earned Income Tax Credit.
3. Child and Dependent Care Tax Credit
If you’re the custodial parent and you pay for any daycare, babysitting, after-school care, nannies, or other care, you may be eligible for the Child and Dependent Care Tax Credit. You can claim a percentage of your expenses, depending on your income, but your total credit can be worth up to $3,000 for one child, or up to $6,000 for two or more children. This tax credit directly reduces your tax bill, so it can be quite valuable.
4. Children’s Dependency Exemption and Child Tax Credit
While the custodial parent generally claims the dependency exemption for any children, there are special rules for more complicated situations. For example, the custodial parent can agree to transfer the exemption to the noncustodial parent. Many couples include this topic in divorce negotiations because the exemption is worth more to the parent who has a higher income.
However, the child tax credit is tied to the dependency exemption, so if you transfer the child’s dependency exemption to the other parent, you cannot take a child tax credit for that child. But your former spouse may be able to claim it. If you wish to transfer the dependency, you can either set this out in the original divorce papers, or you can handle it on a year-by-year basis by completing Form 8332 in any years the custodial parent won’t be taking the exemption.
While divorce is an expensive legal process, legal fees generally aren’t deductible. However, the IRS does give you a break if you paid legal bills to secure taxable income, such as alimony. Legal fees you incur while securing child support, custody arrangements, or other items that don’t produce taxable income are not deductible.
You can also deduct fees that you paid to get tax advice. For example, if your lawyer paid a consultation fee to a tax attorney to determine how the divorce will affect your taxes, that consultation fee is tax deductible. This deduction is part of the miscellaneous deductions on Schedule A – only the portion that exceeds 2% of your adjusted gross income is deductible.
While dealing with a divorce, it’s highly unlikely that you’re thinking about your taxes. And unfortunately, unless a lawyer brings up tax topics, you may not get around to handling your newfound tax situation until it’s a little too late to research the smartest moves and negotiate a better position for yourself.
Rather than cave in to the complexities of divorce proceedings and end up owing a lot more after a tough year, be proactive and look ahead. Take the time to work with your accountant and come up with an honest and effective way to maximize your deductions and minimize your liability.
What were the biggest tax issues you ran into after a divorce?