Tax & Financial Impacts of Divorce: 10 Mistakes to Avoid

Divorce is something no one hopes will happen to them when they get married. Unfortunately, almost half of all marriages end in divorce. Since few people have pre-nuptial agreements, most divorces involve often bitter tangles over children, money, and assets. When it comes to the tax and financial implications of divorce, often your divorce attorney is not the only one you should rely on for advice.

I have found ten very common mistakes that people make in the divorce process. A tax or financial pro can help you avoid them.

1. Don’t let emotions guide you in determining the divorce settlement. Divorce is about a lot of things, but is caused mainly by emotional issues or financial problems in the marriage. You may love or hate your soon-to-be ex, but you cannot rely on your “gut” feelings that they will do right by you or the children. You must make the settlement using reason and planning for the unexpected. He or she may want to pay a large alimony and a small amount in child support by telling you they want to see you are “taken care of.” That may result in less tax for them, a lot more taxes for you and destitute children should you die before they reach 18. Financial planning is critical.

2. Get a good family law attorney, but don’t forget to hire a financial professional to assist in evaluating assets and financial strategies. It may cost extra fees, but it will result in a far better settlement for you in most cases. A Certified Public Accountant (CPA), Certified Financial Planner (CFP), or an Enrolled Agent (EA) can be of invaluable help. What is the house really worth? If a business is involved, what are the consequences of its disposition or the true value of it in the divorce settlement? Your spouse might tell you their business is losing money or has no assets; you need to know the truth!

3. Getting the house in the divorce is not always a good deal. Women often want the house in the divorce because they are raising a family in it or have decorated it and are emotionally attached to the property. If it has a mortgage attached to it, think long and hard about the house. It might be better to sell it and split the equity. If you aren’t working and are raising kids, do you really want a big mortgage payment?

4. Failing to fight for the most child support you can get! Large alimony and low child support payments are generally not a good deal to the spouse getting the payments. Alimony is tax deductible to the party paying but taxable to the party who receives it. A large payment is a large tax deduction for one party and a big tax burden to the person getting it. Child support is tax free to the recipient and not deductible to the payer. Also, alimony may terminate upon marriage or death, but Child Support continues until the child reaches 18.

5. Failure to specify who can claim the kids on the tax return. The divorce should specify who will be entitled to claim the children. Also, Form 8332 Release of Claim may need to be filed with IRS in some circumstances.

6. Lack of planning with regard to life insurance. Life insurance should be reviewed in the event of divorce. You may want to take your ex off of your policy as beneficiary, but do you really want to make your children beneficiaries? Unless they are over 18, this can be a big mistake as the funds may go to a trustee until the kids reach majority. Consult with your attorney on how to style your life insurance to best provide for the kids. If you are the person getting alimony or child support, it is a very good idea to carry a life insurance policy on your ex in the event of death. Otherwise the money stops coming and you may end up homeless.

7. No income modeling done in the calculation of alimony. Your spouse may be a corporate executive and have great future earning potential. He or she may have stock options. An income model should be made to determine the potential they have and how it can affect your claim in the divorce.

8. Failure to secure a Qualified Domestic Relations Order (Quadro) in the event of a 401K or other tax impacted investment that is divided in the divorce. If you don’t do the right thing, huge tax penalties can be imposed on taking money out of IRAs, 401Ks, or Annuities. A good family law attorney can help with this but your Uncle Joe who handles bad check defense may not be the guy you want to do your divorce. He or she may not be familiar with a Quadro.

9. Failure to have assets professionally appraised. If you have rent houses, oil and gas investments, etc. Get a professional valuation or you may be cheated in the divorce settlement. The spouse who handles these investments may not be honest with you on the values. Just because he or she loves the kids or was married to you for thirty years does not mean you can trust them.

10. Lack of faith in yourself and your future. Divorce is bad but it is not the end of the world! You may have some tough times but your life will go on and it may be a blessed life. You don’t know what tomorrow brings. It may bring love and happiness. You must have faith in yourself so that you can take care of the kids and be successful in whatever you choose to do. Money is not everything, but if you don’t have faith in God and yourself, you won’t be financially successful.

Well that is my list and it is my prayer that it has helped you in some way. Be strong and be forceful. Don’t get walked on!

James Robert Coleman, E.A., A.T.A.
Enrolled Agent & Accredited Tax Advisor
Member: National Association of Enrolled Agents
Former IRS Revenue Officer, GS-11
http://www.exirsman.com

Filing Taxes as Separated or Divorced

Q: What is my filing status? (Married, Single, Head of Household)

A: Marital standing at year end determines your filing status for the entire year. If you have a decree of divorce or separate maintenance, signed by a judge, you should file as single. Regardless of whether you have a signed decree you may be able to file as head of household. Filing as head of household may reduce your income tax obligation, but to qualify the following conditions must be met:

• You paid more than ½ the cost of keeping up your home for the tax year.

• Your home was the main home for your child for more than ½ the year.

• Your spouse hasn’t been a member of the household for 6 months.

If you can’t file as single or head of household, then you must either file as married filing joint or married filing separate.

Q: Is child support taxable?

A: No. Child support is neither taxable to the recipient nor deductible to the payor. If the payor owes both alimony and child support but pays less than the total amount owed, the payments apply first to child support and then to alimony. If the separation agreement doesn't delineate separate alimony and child support payments, general "family support" payments are treated as child support for tax purposes, unless the alimony qualifications are met.

Q: Are my divorce costs deductible?

A: In general legal fees are considered personal expenses so they aren’t deductible.
However legal fees paid to get alimony and legal fees regarding the tax effects of divorce are deductible. The attorney must allocate fees paid for deductible and non-deductible services otherwise the deduction may be disallowed. The allowed deduction is a miscellaneous itemized deduction which is deductible only to the extent that, in the aggregate, the miscellaneous deductions exceed 2% of the taxpayer’s adjusted gross income. Some are your legal fees may be deductible, such as fees for securing income.

Q: Who gets to claim the dependency exemption for the children?

A: In general, as long as the parents combined contribute at least ½ of the support of the child, the custodial parent gets the dependency exemption for the child. If custody is split or undeterminable, the parent who had physical custody for the greater part of the year gets the dependency exemption. Custodial parents can waive their right to the dependency exemption.

Q: Is alimony taxable?

A: In general, alimony is taxable to the recipient and deductible to the payor (line 31a of the 2006 Form 1040). However, some couples stipulate in their separation agreement that the alimony won’t be deductible to the payor, or taxable to the recipient. Alimony is deductible on page 1 of the 1040 form so you don’t need to itemize your deductions to take it as a deduction. If you don’t have any other income you can still make IRA contributions. Alimony is considered earned income (Form 1040, line 11). Anyone receiving alimony, especially without wages, may need to make estimated tax payments throughout the year in order to avoid penalties when they file.

Q: Are there any tax benefits if I am paying alimony?

A: If you are paying alimony, you can use your payments to reduce your gross income.

Q: Should my spouse and I file as married, filing separate or married, filing joint?

A: Filing joint may provide some tax benefits over filing separate. However, by filing separate the IRS can’t hold you responsible for any unpaid taxes caused by your spouse’s actions or omissions. The “innocent spouse” rule provides relief from this responsibility in some cases.

Q: Who claims the Child Tax credit and the Household and Dependent Care credit?

A: Only the parent who claims the exemption for the child may claim the Child Tax credit for that child. Unlike the exemption, it can’t be traded. If you are the custodial parent, you can claim the Household and Dependent Care credit for the child even if you cannot claim the child’s exemption. If you are the non-custodial parent, you cannot claim the Household and Dependent Care credit for the child even if you can claim the child’s exemption.

Q: Who gets the mortgage interest deduction and other itemized deductions?

A: If the marital home is owned by one spouse alone, only that spouse may claim a mortgage interest deduction. Deductible expenses that are paid out of separate funds, such as medical expenses, are deductible by the spouse who pays them. In general, deductible expenses paid out of joint funds are split 50/50 between the spouses, including mortgage interest. Mortgage interest for property titled by the entireties can be claimed by whichever spouse actually paid the expense.

Q: My spouse and I are using the married, filing separate filing status. Can I use the standard deduction if my spouse itemizes?

A: No. If spouses are using the married, filing separate filing status and one spouse itemizes their deductions, the other spouse must itemize as well. You must coordinate this with you spouse because if you file first and take a standard deduction and your spouse itemizes, you may have to file an amended tax return.

Rosen Law Firm has offices in Raleigh, Charlotte, and Chapel Hill. Founded in 1990, the firm is dedicated to providing individual growth and support to couples seeking divorce by helping them move forward with their lives. Our staff of attorneys and other legal professionals expertly address the complex issues of ending a marriage. Our innovative approach acknowledges that divorce is so much more than just a legal matter. Practice areas include child custody, alimony, property distribution, separation agreements, and domestic violence relief.

Contact: Alison Kramer, 919-459-8157, akramer@rosen.com

Divorce and Uncle Sam: Top 10 Things You Should Know When Filing Your Taxes

1. What is my filing status? (Married, Single, Head of Household) Marital standing at year end determines your filing status for the entire year. If you have a decree of divorce or separate maintenance, signed by a judge, you should file as single. Regardless of whether you have a signed decree you may be able to file as head of household. Filing as head of household may reduce your income tax obligation, but to qualify the following conditions must be met:

o You paid more than ½ the cost of keeping up your home for the tax year,

o Your home was the main home for your child for more than ½ the year, and

o Your spouse hasn’t been a member of the household for 6 months.

If you can’t file as single or head of household, then you must either file as married filing joint or married filing separate.

6. Should my spouse and I file as married, filing separate or married, filing joint?

Filing joint may provide some tax benefits over filing separate. However, by filing separate the IRS can’t hold you responsible for any unpaid taxes caused by your spouse’s actions or omissions. The “innocent spouse” rule provides relief from this responsibility in some cases.

2. Is alimony taxable?

In general, alimony is taxable to the recipient (line 11 of the 2004 Form 1040) and deductible to the payor (line 34a of the 2004 Form 1040). However, some couples stipulate in their separation agreement that the alimony won’t be deductible to the payor, or taxable to the recipient.

3. Is child support taxable?

No. Child support is neither taxable to the recipient nor deductible to the payor.

If the payor owes both alimony and child support but pays less than the total amount owed, the payments apply first to child support and then to alimony. If the separation agreement doesn't delineate separate alimony and child support payments, general "family support" payments are treated as child support for tax purposes, unless the alimony qualifications are met.

4. Who gets to claim the dependency exemption for the children?

In general, as long as the parents combined contribute at least ½ of the support of the child, the custodial parent gets the dependency exemption for the child. If custody is split or undeterminable, the parent who had physical custody for the greater part of the year gets the dependency exemption. Custodial parents can waive their right to the dependency exemption by filing Form 8332.

5. Who gets to claim the Child Tax credit and the Household and Dependent Care credit.

Only the parent who claims the exemption for the child may claim the Child Tax credit for that child. Unlike the exemption, it can’t be traded. If you are the custodial parent, you can claim the Household and Dependent Care credit for the child even if you cannot claim the child’s exemption. If you are the non-custodial parent, you cannot claim the Household and Dependent Care credit for the child even if you can claim the child’s exemption.

7. Are my divorce costs deductible?

In general legal fees are considered personal expenses so they aren’t deductible.

However legal fees paid to get alimony and legal fees regarding the tax effects of divorce are deductible. The attorney must allocate fees paid for deductible and non-deductible services otherwise the deduction may be disallowed. The allowed deduction is a miscellaneous itemized deduction which is deductible only to the extent that, in the aggregate, the miscellaneous deductions exceed 2% of the taxpayer’s adjusted gross income.

8. My spouse and I are using the married, filing separate filing status. Can I use the standard deduction if my spouse itemizes? No. If spouses are using the married, filing separate filing status and one spouse itemizes their deductions, the other spouse must itemize as well.

9. Who gets the mortgage interest deduction and other itemized deductions?

If the marital home is owned by one spouse alone, only that spouse may claim a mortgage interest deduction. Deductible expenses that are paid out of separate funds, such as medical expenses, are deductible by the spouse who pays them. In general, deductible expenses paid out of joint funds are split 50/50 between the spouses, including mortgage interest. Mortgage interest for property titled by the entireties can be claimed by whichever spouse actually paid the expense.

Jessie Danninger is a financial analyst with Rosen Divorce. She assist clients in all financial matters relating to divorce, including property distribution, child custody, alimony, and tax related issues. She is a certified divorce financial analyst and CPA.

With offices in Raleigh and Charlotte, Rosen Divorce is the largest divorce firm in North Carolina. Founded in 1990, the firm is dedicated to providing individual growth and support to couples seeking divorce by helping them move forward with their lives. Our staff of attorneys, accountants, and specially trained divorce coaches expertly address the complex issues of ending a marriage. Our innovative approach acknowledges that divorce is so much more than just a legal matter. Specialties include child custody, alimony, property distribution, separation agreements, and domestic violence relief.

For more information on Rosen Divorce, or for an interview, please contact: Alison Kramer, Director of Public Relations, Office: 919-256-1542, Cell: 919-523-7104 akramer@rosen.com

ROSEN DIVORCE 4101 Lake Boone Trail, Suite 500 Raleigh, NC 27607 http://www.rosendivorce.com  ”Divorce is Different Here”

Tax Deduction for Alimony Payments

Over 50% of marriages end in divorce in the United States. Many divorce decrees include provisions for the payment of alimony. The IRS takes the position that such payments constitute a form of income and create an alimony tax deduction for the person making payments.

According to the IRS, alimony payments are taxable to the recipient in the year received. In turn, the person paying the alimony can claim a deduction for the payments if the following tests are met:

1. You and your spouse or former spouse do not file a joint return with each other,

2. You pay in cash (including checks or money orders),

3. The divorce or separation instrument does not say that the payment is not alimony,

4. If legally separated under a decree of divorce or separate maintenance, you and your former spouse are not members of the same household when you make the payment,

5. You have no liability to make any payment (in cash or property) after the death of your spouse or former spouse; and

6. Your payment is not treated as child support.

If you are receiving or paying alimony, you must use Form 1040 for your personal taxes. Regardless of income levels, deductions or miscellaneous tax issues, you cannot use Form 104A or Form 1040EZ.

In preparing your tax return, the person receiving alimony will report the information on line 11 of Form 1040. That person must also provide their social security number to their former spouse or face a fine of $50. The person paying the alimony can claim the deduction on line 34a of Form 1040.

Richard A. Chapo is with http://www.businesstaxrecovery.com  - recovery of business taxes through tax help and tax relief. Visit http://www.businesstaxrecovery.com articles to read more business tax articles.

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