Divorce Tax Return Q&A: Tips to Simplify Tax Season
Much like winter in Westeros, Tax Day is coming. If you’re divorcing or recently divorced don’t let April 15 stress you out. Here are the top six tax questions related to divorce and the advice you need to ace your post divorce tax return.
- Which filing status should I choose?
- How will a name change affect my return?
- Will I pay taxes on the spousal support I receive?
- Can I deduct legal fees from the divorce on my return?
- Will our assets be taxed after we divide them?
- Who claims the children on their taxes?
Which filing status should I choose?
The date your divorce is finalized dictates your filing status options. Pay attention to whether the court approved your final divorce order by December 31st of the tax year. A divorce finalized during the tax year (see example During the Tax Year below) allows you to choose single or potentially head of household as your filing status. Alternatively, if a divorce was not finalized during the tax year (see example After the Tax Year below) choose either married filing jointly or married filing separately.
After the Tax Year
Scenario: At the end of October 2016, Sansa filed for divorce in King County Superior Court. After the mandatory ninety day waiting period the court finalized the divorce in January 2017. She is now filing her 2016 taxes. Which filing status should she choose?
Since the court finalized the divorce in 2017, after the tax year, she can choose either married filing jointly or married filing separately. So which option is better?
The Married Filing Jointly Advantage
In general, the status married filing jointly offers the best tax rates. The major drawback is that Sansa can be held accountable for problems with the joint return that may be caused by her ex-husband. If Sansa does not prepare the forms herself, she will want to review them carefully before they are filed. Overall, the taxes saved when selecting married filing jointly make it the best choice for the majority of people, including Sansa.
During the Tax Year
Scenario: Stannis filed for divorce in Pierce County Superior Court in September of 2016. He received the approved divorce order in December. When he files his 2016 return in April, which filing status can he choose?
Since the court finalized the divorce during the tax year, on December 2016, Stannis can select single or possibly head of household.
The Head of Household Advantage
Head of household offers more tax benefits, so Stannis should determine if he qualifies. In most cases, only the custodial parent is eligible to claim head of household. The custodian is the parent the children are scheduled to spend the majority of their time with. To check your designation look at Section 7 of your Washington Parenting Plan.
In some instances neither parent is eligible. Neither parent is eligible when there is joint custody. If Stannis and his ex-wife spend equal time with their daughter and share expenses, neither is eligible for head of household.
Rarely are both eligible. If they had multiple children and some live primarily with Stannis, while the others live mostly with their mother, it is possible. Specific language needs to be included in the divorce agreement detailing the arrangement.
Timing Tax Tip
Here’s an easy divorce tax tip for those filing around fall. Time your divorce filing so it is approved in the year most beneficial to you. For instance, you may save the most tax dollars if you claim married filing jointly as your status. In that case, delay filing until early October. When the court processes your divorce documents in January, you’ll have access to the beneficial status in your post divorce tax return.
How will a name change affect my return?
Section 19 of the Washington Petition for Divorce allows you to request a name change. If you decide to change your name you should alert the Social Security Administration (SSA) as soon as possible. Remember that if you use online software to submit your return, your name must match both the records of the IRS and SSA.
Your return will likely be rejected if you did not update your name in time and you’ll need to file by mail. This is fine if the IRS owes you a refund, but risky if you owe taxes. If you waited until the deadline and owe taxes, you may only have a few days to submit your return by mail without incurring penalties.
Will I pay taxes on the spousal support I receive?
On January 1, 2019 spousal support taxes changed in a big way. In order to determine how to treat support payments on your taxes look up the date your support agreement was signed.
If your settlement agreement or divorce was finalized on December 31, 2018 or before, spousal support or alimony, referred to as maintenance in Washington, is considered income. A spouse who receives support will need to pay taxes on that support. Conversely, the spouse paying support will be able to claim a tax deduction on the amount paid. The trick is to know which payments count as support.
Problems arise when one spouse believes payment to be support and the other does not. Support does not always take the form of direct cash payments. As long as a payment matches the criteria for spousal support, it can be deductible. To avoid confusion, ensure that your agreement specifically states, which payments are deductible.
Here’s an example of spousal support confusion.
Cersei pays $10,000 in tuition for her ex-husband Robert’s schooling. Cersei also pays $20,000 throughout the year in direct spousal support. When filing her return, Cersei claims $30,000 in tax deductions. However, Robert only budgeted to pay taxes on $20,000 in support payments and did not realize that the tuition costs were also deductible. He now owes taxes on an additional $10,000 in income.
Don’t be caught off guard at tax time. If Robert designated, which payments were tax-deductible when drafting the divorce, he would have known that Cersei expected to claim a tax deduction on the $10,000 tuition payment.
January 1, 2019 Forward
For any spousal maintenance arrangement made on or after January 1, 2019 the tax burden is reversed. Maintenance is no longer tax deductible. In a nutshell, the spouse paying support will also pay the taxes and the receiving spouse will get the money tax free.
Using the above example, Cersei would not be able to deduct the $30,000 paid for Robert. Consequently, Robert would not pay taxes on the alimony received.
Can I deduct divorce legal fees from my return?
For the most part you cannot deduct legal fees associated with your divorce. Elements that can be included are incorporated into a miscellaneous expense category. This group of expenses must exceed 2% of your adjusted gross income in order to claim a deduction.
If you think you may exceed the 2% threshold and qualify for the deduction, here are three deductible legal costs. First, you can to deduct the cost of legal work done for maintenance. Second, you may deduct fees associated with dividing a qualified retirement plan. Third, you can deduct legal expenses specific to tax issues. Ask your attorney to make it easy for you and break down the bill, identifying which portions qualify.
Will our assets be taxed when we divide them?
Property transferred between spouses pursuant to a divorce is not subject to taxation. Some assets, like real estate, will incur taxes down the road, but you won’t need to pay additional taxes if you receive ownership as part of the divorce. Therefore, a good rule of thumb is to reduce the number of transactions in order to avoid additional fees.
Here is the strategy in action.
Tommen and Margaery own a $500,000 home with a $200,000 mortgage and a bank account worth $300,000. They decide to divide the property evenly. Margaery keeps the home, while Tommen receives the $300,000 in cash. Even though they walk away with different types of assets, real estate and cash, the IRS will treat Tommen and Margaery the same. No additional taxation occurs.
Imagine instead that Margaery and Tommen decide to sell the home and split the proceeds. To start they are likely to pay 5% in a sales commission fee. They’ll collectively lose $25,000 from the sale. In addition, they’ll need to deal with the stress, time commitment, and expense of preparing the house for sale. They’ll also incur additional fees and possibly capital gains taxes from the sale of the property.
A sale will result in less community property overall. Keep property intact if you have the means. It protects assets from transaction fees and simplifies the divorce process.
One word of warning, if you keep the house make sure you can afford it. Many times a spouse takes over a home with a large mortgage, but has relatively little income. This might happen because they expect to land a new job and want to keep the children in the same home.
Problems occur when things don’t go as planned. Maybe the new job doesn’t come through, a car accident results in a big hospital bill, or the hot water heater breaks. If the house is the spouse’s only asset they might be forced to sell the home to pay the bills. A quick sale will not only fetch a low price, but the transaction fees can eat the profits and leave the spouse with next to nothing.
Who claims the children on their taxes?
Section 18 of the Washington Child Support Order allows you to designate who can claim the children as dependents for tax purposes. Some spouses elect to trade-off every other year. Others choose the parent with the higher income, since that parent will save the most tax dollars from the deduction.
If left to the court system, Washington judges award the dependency exemption based on multiple factors. Examples include, who will receive the most economic benefit from the exemption and which parent pays the majority of child support.
Here’s a tip, which will help your kids. Evaluate who will claim a child as they approach college. Often a child has access to better financial aid packages if the parent with the lowest income claims them that year.
There is a lot to consider, but hopefully this made it easier to spot the major issues you’ll face in your first tax return after divorce. If you keep these concepts in mind you should have everything in order on Tax Day. If you have further questions or would like more information about Truce Law, please call me at 206.409.4086 or send us a message.