Divorce is far and away one of the most stressful ordeals two people can go through. Many people negotiate and finalize their divorce without taking proper account of the tax impact of their decisions. Here are some tax guidelines to be aware of:
1. Your income-tax filing status is set by your marital status on the last day of the year:
• If you are still legally married, you can file a married-filing-jointly return (the most advantageous filing status for most people); or married filing separately.
• If you’re legally divorced, you must file as single or head of household.
2. Alimony payments are tax-deductible for the ex-spouse making the payments, and the payments are taxable for the ex-spouse receiving the money.
3. Child-support payments are not tax-deductible for the parent paying the support or taxable income for the parent receiving the support.
4. The IRS presumes that the custodial parent is entitled to the exemption for the children. The custodial parent may give the exemption to the noncustodial parent using IRS Form 8332.
5. A non-custodial parent, who pays for medical expenses for a child, can include the costs in their medical-expense deduction.
6. The custodial parent, who is either working or looking for work, can take the child-care credit.
7. The custodial parent paying college expenses is entitled to the American Opportunity Tax Credit (up to $2,500) and the Lifetime Learning Credit (up to $2,000) for the child’s college expenses.
8. There is no tax gain or loss in transferring property during a divorce. However, if you decide to sell the property later, you will have to pay capital-gains tax on all of the appreciation before, as well as after, the transfer.
9. The tax status of pension and retirement benefits is controlled by a Qualified Domestic Relations Order (QDRO). Handle your retirement savings with care in a divorce. For example, if you cash out a 401(k) plan to give the money to your ex-spouse, the IRS considers that a taxable distribution and you’ll be stuck paying the tax. The way to avoid this tax trap is to have the transfer accomplished with a QDRO, which gives your ex-spouse the right to the funds and relieves you of the tax burden.
10. You can’t deduct all fees charged by your divorce lawyer, but you may be able to deduct the cost of tax advice to you when preparing for a divorce. You may also be able to deduct fees and expenses for appraisers, actuaries, and accountants who performed work connected to the divorce.
Divorce can be emotionally trying, but if you plan carefully, you won’t be surprised at tax time. For additional information, refer to IRS Publication 504, “Divorced or Separated Individuals.”
Barry Lisak is an IRS Enrolled Agent, meaning that he has passed special U.S. Treasury Department exams that qualify him to represent clients dealing with audits or tax-resolution cases. Any questions can be directed to him at (516) TAX-SAVE, or firstname.lastname@example.org.