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Avoid These Common Tax Pitfalls In Divorce

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by: No more debt !
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Date: Sun, 26 Jun 2016 Time: 12:14 PM

When divorce is imminent, the last thing on most people's mind is taxes. This is completely understandable, as other issues like children and immediate financial security take immediate priority.

However, failing to understand certain tax pitfalls, can create bigger problems down the road.

Who Gets the Dependency Exemption for the Minor Child

The IRS presumes that the custodial parent will receive the dependency exemption for any minor children of the divorcing couple. A custodial parent is defined as the parent who has the minor children for the greater portion of the calendar year. This presumption can create a situation where one parent always gets the deduction, year after year, providing significant tax savings to him or her.

However, the dependency exemption can be allocated by agreement of the parties or by court order. In such cases, the parent relinquishing the dependency exemption is required to sign IRS form 8332, which is then attached to the non-custodial parent's tax return in each year that he or she claims the exemption.

Alimony is Taxable to the Recipient

With some exceptions, spousal support paid by one party to the other is usually considered a taxable event for both. This is crucial to understand because it causes a tax liability for the payee spouse and a tax credit for the payor spouse.

The IRS sets forth specific criteria in order for a payment between spouses to qualify as alimony:

  • The spouses do not file a joint tax return with each other
  • The payor spouse pays in cash (including checks, bank transfers or money orders)
  • The payment is received by (or on behalf of) the payee spouse
  • The divorce or separate maintenance decree does not state that the payment is not alimony
  • If legally separated, the former spouses are not members of the same household when the payment is made
  • There is no liability to make payments after the death of the payee spouse
  • The payment is not treated as child support or part of a property settlement

How The Property Division Can Impact Taxes

For most divorcing couples, the majority of their marital estate is comprised of retirement accounts. In most cases a Qualified Domestic Relations Order (QDRO) is required to effectively divide these assets. However, there are tax consequences for a spouse receiving a share of the other spouse's retirement accounts. It is important to fully discuss the potential tax liability – and ways to avoid them – with your divorce attorney or financial planner.

The Filing Status to Use While the Divorce is Pending

Many people inaccurately believe that once a divorce is filed, they are no longer entitled to file as "Married Filing Jointly." This it not true. IRS code allows a taxpayer who is married on the last day of the calendar year to file as either Married Filing Jointly, Married Filing Separately or, in some cases, Head of Household.

The IRS makes no distinction for people going through a divorce in any given year. Even if the final court date is scheduled for January 2 of the following year, so long as the parties are still legally married (with no legally binding divorce decree or separation maintenance order in place) on December 31 of the current year, they are entitled to file as Married Filing Jointly. This can be beneficial, as most married couples enjoy greater tax benefits when filing under this status. At the very least, this will shave off a bit of tax liability for the current tax year.

Some Legal Fees Can Be Deducted

One of the most common questions asked by divorcing parties is whether they can deduct their legal fees on their tax return. Unfortunately, while the IRS does allow for the deduction of legal fees related to tax advice from your divorce lawyer, the balance of his or fees is non-deductible.  For this reason, it is critical to ensure your divorce lawyer prepares an itemized invoice, as it is your responsibility to provide support for any deductions you take.

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