Financial Planning and Tax FAQ's

How will I file my tax return in the year of my divorce?

Nothing will change until you have a signed divorce decree or separation agreement that is final. Generally your filing status for the year is determined by your marital status on December 31. Therefore, if you have been granted a divorce at any time during the year on or before December 31, you will be considered as a single taxpayer for the entire year, as long as you haven't remarried by the end of the year.

Who claims the dependency exemption for the children?

This should be spelled out in your agreement. An analysis should be done to determine which parent derives the greatest tax benefit for the “family”. This way the overall cash available to the family is maximized due to the tax savings, which can then be utilized for meeting other cash demands.

If your agreement is silent to this matter, then the custodial parent has right to the dependency exemption, assuming that both parents together provide more than half the support of their children. This could be waived by the custodial parent by signing Form 8332. In joint custody arrangements, the parent with more time with the child(ren) will have right to the exemption. For parents with children under age 17, this exemption can be quite valuable, because the child credit of $1,000 follows the dependent.

How can one qualify for Head-of-Household filing status?

Head-of-household (HOH) is available to those taxpayers who are considered unmarried for tax purposes, who maintain a home for a dependent child for more than half the year, and who pay more than half the cost of maintaining that home. Those that meet the qualifications do not need to actually claim the dependent child who lives with them. Therefore, the custodial parent could relinquish the exemption to the non-custodial parent without jeopardizing his or her HOH status.

Will I pay taxes on the support I receive?

For spousal support, the answer is generally yes. Unless your agreement states that the spousal support is nontaxable and nondeductible, and as long as it meets the Internal Revenue Code definition of spousal support, it will be considered taxable income. The tax cost of spousal support should be figured as part of your budget when determining your net cash flow, and a system should be put into place to pay the appropriate taxes quarterly in order to avoid possible penalties.

Child support is nontaxable and nondeductible. In some instances, a portion of spousal support may be considered nontaxable child support if reductions in spousal support occur due to child-related events.

Will I pay taxes on the transfer of property related to my divorce?

The transfer of property between spouses and former spouses is generally tax-free. There are time restrictions under which such transfers must occur in order to remain tax-free. Though no taxes are usually due at the time of the transfer, future taxes may be owed by the spouse/former spouse who acquired certain assets. The original cost (or basis) stays with the asset transferred, and the taxes on the future sale of an appreciated asset will be the responsibility of the owner of the asset. For this reason, it is important to know the tax cost that has been accruing during the marriage and valuing all the appropriate assets as to their net-of-tax value in working towards an equitable division. For example, if two spouses were to receive gross assets of equal value, one receiving stocks that have appreciated and the other spouse receiving cash, the two individuals do not have equal amounts of liquid assets. The one receiving the stock has less in hand after liquidation due to the taxes owed.

What should I consider in reviewing my options concerning the marital home?

For most couples, the marital home and the retirement plans are the largest pieces of their net worth. But unlike a retirement plan, which could continue to grow without cash infusion, a home, even if paid for, tends to be a costly asset. First, unless paid for, the mortgage is due monthly. Real estate taxes will be owed during your ownership of the property and insurance and utilities will most likely increase over time. Can you afford this based on known income projections? Are you straining your finances in order to stay? Will you have the time, between work and children, to maintain the current home? Think seriously about keeping this asset; once the agreement that transfers ownership to you is signed, you are stuck with it until you sell, and most times the selling costs are not deducted from the value unless selling is in the near future. You'll pay 100% of the cost to dispose of this asset.

Can retirement assets be accessed prior to retirement?

The answer really depends on the type of retirement plan. Though retirement plans should remain untapped for future use, sometimes, after a divorce, they represent a means of funding an unforeseen expense or for a down payment on a home. Even if you are not contemplating accessing these funds, you should know, prior to any agreement, how and when these funds may be accessed. Some plans may be drawn upon by the non-participant spouse after the plan administrator divides the plan, some may be accessed by rolling the account to an IRA, and others will be inaccessible until the participant spouse retires. All facts regarding the plan should be known in order to devise a plan that minimizes the tax costs of such transactions.