Don’t complete your final settlement until you understand the potential future tax consequences.
Regardless of what your settlement agreement states, the IRS and California Franchise Tax Board regulations dictate what is taxable, what is deductible and how much tax you will have to pay.
Here are some of the most common tax related issues that should be addressed:
Should I file as Married Filing Jointly, Married Filing Separately, Single or Head of Household?
If you are legally married on the last day of the year, you are eligible to file as Married Filing Jointly or married filing separate. In most cases, the combined tax is less if you file jointly. If you are no longer married as of the last day of the year, you have to file as Single, unless you qualify to file as “Head of Household.” You may qualify to file as Head of Household if you pay more than 50% of the cost to maintain a house for a “qualifying” person, such as a child or a parent.
Am I eligible to claim an exemption for my child/children as dependents?
The general rules require that your child must be under age 19 (or under age 24, if a full-time student), must have lived with you for more than half of the year and did not provide more than half of their own support. In the case of children of divorced or separated parents, there are special rules that allow either parent (not both) to claim a child as a dependent in any given year.
Who is responsible for the tax liability related to a tax return filed jointly?
If you are divorced you remain jointly and individually liable for any tax, penalty and interest related to a return you filed as Married Filing Jointly. This applies even if your divorce decree states that your former spouse will be solely responsible. There are procedures that allow for relief from tax liability in the case of an “innocent spouse”; however it is best to avoid filing a joint return if you have any concerns about the accuracy of the tax return.
Do I Pay Tax On Spousal Support (Alimony) and Child Support?
The general rule is that spousal support is taxable to the party who receives it and is deductible by the party who pays it – and the parties cannot file a joint return.
As with many provisions of the tax code, there are exceptions! For spousal support to qualify as a tax deduction for the payer and be taxable to the payee, the divorce decree must meet specific requirements. If the requirements are not met, the payments do not qualify as a tax deduction and are not taxable.
Child support is not taxable to the payee and is not tax deductible for the payer.
Understanding how the terms of your settlement agreement may affect your income tax liability, before you reach a final agreement, allow you to make decisions that can result in a better tax outcome for BOTH parties.
Working with a Divorce Financial Specialist during the divorce process can help you identify financial and tax related issues that may not be consistent with you best interests.