Taxes and Divorce

As with all tax matters, please consult with a tax professional, accountant or tax attorney before taking any action regarding a property division or maintenance (alimony).  Once you file for divorce, it is important to understand your new options and how they might affect your income taxes.

Change in filing status

If you remain married at the end of the calendar year, you will have the choice to file jointly or separately. If you and your spouse file jointly or together, you may be responsible jointly for the tax  and any interest or penalty due on the joint return. You can be held liable for all of the taxes due even if all the income was earned by the other spouse. If you have substantial questions whether a joint tax return has been accurately completed, you may want to file separately. If you file a separate return, you will be reporting only your own income, exemptions, deductions and credits. Normally, you need to reach an agreement to divide joint deductions such as the mortgage interest deduction or the deduction for property taxes, but there are exceptions. Separately filing a tax return may give you a higher tax rate than on a joint return. You also cannot take the same tax credits or deductions in some cases.

Some Divorce Costs are Deductible:

You cannot deduct legal fees or court costs for getting a divorce. However, you may be able to deduct legal fees paid for tax advice in connection with a divorce, and legal fees you incur to get maintenance (alimony). In addition you may be able to deduct fees you pay to appraisers, actuaries, and accountants for services in determining your correct tax or in helping to get maintenance. Likewise, you can add certain legal fees you pay for a property settlement to the basis of property received, such as adding the cost of preparing and filing a deed to put title to your house in your name alone.

Visitation Can Affect Taxes:

The parenting time, or visitation, awarded to each the parents is also important as the amount of time can qualify the majority time parent to receive the benefits of filing as “head of household.” If you file under this status your standard deduction is higher than is allowed if you claim a filing status of single, or married filing separately. Your tax rate will usually be lower, and you may be able to claim certain credits not otherwise available, such as the dependent care credit and the earned income credit. Further income limits that reduce a child tax credit, retirement savings contribution deduction, and other itemized deductions are also higher. In order to qualify though you must be either unmarried or “considered unmarried” (see a tax professional) on the last day of the year, and the child must have lived with you for more than half the year-even one day more.  There are further requirements also, for which a tax professional can help you decide if you qualify.

Dependent Exemptions:

The exemptions for dependents can be a valuable benefit as they currently allow for a deduction of $3900, which is phased out for adjusted gross incomes more than $150,000. Only one parent can claim the exemption for a dependent child. Separation agreements or court orders can divide dependent exemptions between parents for each tax year. Usually, the division of dependent exemptions takes into consideration the parties’ relative gross incomes.

Deductions for Alimony Paid:

Alimony (maintenance) is a payment to or for a spouse or former spouse in a divorce that is required by an order or agreement. Maintenance is deductible by the payer and must be included in the spouse or former spouse’s income. A further benefit of paying maintenance in Colorado is that it decreases the payor’s gross income and increases the payee’s gross income for purposes of calculating child support. Paying maintenance can therefore not only reduce a tax bill, but can also reduce the child support to be paid. Divorcing parties need to be aware though that if maintenance payments decrease during the first three calendar years of a divorce may be subject to the recapture rules of the IRS for maintenance. This means you would then have to include in your income in the third year part of the maintenance payments you previously deducted. A party is subject to the recapture rule in the third year if the maintenance paid in the third year decreases by more than $15,000 from the second year, or the maintenance paid in the second year decreases significantly from the maintenance paid in the first year. Please see a tax professional or attorney before reaching any agreement wherein there is a significant reduction in the amount of maintenance to be paid over any three-year period of time.

Retirement Account and Health Savings Account Transfers:

Parties must also be aware that when property is divided, often the retirement accounts are the largest single assets. Generally, there is no recognizable gain or loss on the transfer of property between spouses, or between former spouses, because of a divorce. However, if there is the transfer of certain types of retirement funds from one party to the other, and the transfer is not done pursuant to a qualified domestic relations order (QDRO), the transferred amount may be subject to taxation and penalties. Generally, all transfers will have to be from one retirement account to another to avoid taxation, and some transfers do require a QDRO before the transfer. Likewise, there can be some risk in transferring funds held within a health savings account, an Archer medical savings account, or an IRA. As long as these transfers are done incident to a divorce and are made from and into a similar type account, the transferred amount will not be recognized as income. However, please consult an accountant, attorney or tax professional if there are any questions.