Divorce & Taxes
It is unfortunate that anyone should be expected to think about taxes in the midst of a separation. The fact is, however, it is wise to consider the tax consequences of your actions before you sign a divorce agreement. The tax implications of a divorce are many and cannot be covered in entirety in this article but there are some general concepts that may be considered when contemplating divorce. Of course, the situation will vary greatly depending on the economic status of the parties, whether or not children are involved and whether or not there is property. The tax consequences will also be affected by state laws, which determine how property will be distributed in a divorce.
Two big issues that come up in a divorce related to the children. First, there is child support- what are the tax consequences? Second, there is the question of which parent will claim the child as a dependent.
Child support is not taxable. It is not income to the recipient spouse and it is not deductible for the payer. A problem that sometimes arises with child support is that the child support payments are intertwined with alimony payments. The alimony payments are deductible for the person paying but child support payments are not. If the IRS sees that part of the “alimony” expires when the child reaches a certain age or upon the happening of some event related to the child the IRS will treat that amount as being specifically designated for child support even if the divorce decree says otherwise.
Claiming a child as a dependent can have beneficial tax consequences, so it can be a point of contention for divorcing couples. Determining which parent “claims” the child may also have emotional undertones. In the past, the custodial parent is the one who would be entitled to take a tax exemption but now, parents have the option of deciding who gets the exemption. The parent who claims the exemption can also claim education credits for the child. Parents who use this arrangement must file a form with the IRS in order to designate which parent will claim the child.
Since it is now possible to negotiate who will claim the child, it is a good idea to consult a tax attorney or accountant in order to determine who would benefit most from the exemption. Also, take note that, unlike education credits, credits for childcare costs cannot be passed back and forth between the parents. Only the parent with custody of the child can claim these credits.
There are many ways that the home can be dealt with, each with varying tax consequences. This is an issue that will also be affected by state laws on distribution of property. However, there are some basic some considerations to keep in mind.
The transfer of property incident to divorce is not a taxable event. There is no taxable gain or loss to either party. Note that “transfer” does not mean “sale.” The transfer or property means that one spouse take the house as part of the divorce agreement.
If the house is sold in order to share the proceeds then the amount gained or loss must be acknowledged for tax purposes. The amount claimed will depend on state law. If the home that is sold is the “principal residence” then some portion of the proceeds may be excluded from tax liability. The amount that will not be recognized as gain on the sale is $250,000 for individuals and $500,000 for spouses filing jointly.
Alimony payments are income for the recipient and deductible for the payer. It can be a tax advantage for the payer to include certain payments under the category of “alimony.” Alimony can include insurance (medical and life), mortgage payments, and car payments. As discussed above, however, child support is not alimony and any portion of the alimony that appears, in actuality, to be support for the child, will be considered child support by the INS. Since there can be tax advantages and disadvantages of alimony it may be worthwhile to explore which payments could (and should) be made in the form of alimony by consulting a tax attorney. People sometimes run into trouble when they mischaracterize something as alimony.
Finally, there is one bit of good news about divorce and taxes. The IRS allows a tax deduction for the cost of consulting a tax attorney incident to the divorce. The legal costs related to the divorce are not deductible but the tax consultation costs are. If the same person is hired to address both issues, they must maintain careful records so that the amount charged for the tax services can be determined. Keep in mind, however, that this deduction can only be claimed if the taxpayer itemizes deductions. In addition, the amount of the overall deduction may be limited based on the taxpayer’s Adjusted Gross Income.
Am I eligible to exclude some of the proceeds from the sale of my home from my tax liability?
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