1. You can file "Married Filing Jointly" Even Thought the Divorce Action is Pending
A taxpayer who is married on the last date of the year may file as Married filing jointly, married filing separately, or in some circumstances, as Head of Household. However, as far as the IRS is considered parties who are separated but who do not have a divorce degree or separate maintenance order in effect is considered married for tax return purposes. This is true even if your divorce trial is in early January the next year.
This can have significant benefits if the couple has marital home they need to sell as a part of the divorce resolution. With more and more houses with negative equity, partition of the marital home is increasingly common.
At the very least, filing jointly with your soon to be former spouse can put a couple extra dollars in both of the parties pockets.
(For more information, please see Should We File Joint or Separate Tax Returns During a Divorce?)
2. The Dependency Exemption Can Mean Big $$
The IRS presumes that the custodial parent will get the dependency exemption. The custodial parent is defined as the parent who has the child for the greater portion of the calendar year. IRC Sec. 152€(4)(A). A child is treated as a qualifying child when the parents are divorced, separated under a written separation agreement, or who lived apart at all times during the last 6 months of the calendar year.
However, there are exceptions to this rule. Specifically, if the custodial parent signs a written declaration that the custodial parent will not claim the child as a dependent, and the noncustodial parent attaches the written declaration to the non-custodial tax return.
Therefore, a noncustodial parent can negotiate with the custodial parent in the Marital Settlement Agreement for the dependency exemption. However, the Code makes it clear that a form 8332 or an equivalent substitute needs to be attached to the return. It is often prudent to get the custodial parent to sign a Form 8332 at the time of signing the settlement agreement to keep from having issues later.
3. Make Sure Alimony is Taxable to Payee Spouse
Classifying a payment as alimony or maintenance in the final judgment of your divorce does not mean the IRC will treated it as such for tax purposes. Rather, there are certain statutory requirements that are met, specifically: a cash payment, in the divorce decree, not designated as includable in gross income, not liable to make the payment after the death of the payor spouse. Finally, the parties cannot file a joint return for the year it is paid. A deduction is allowed to the payor spouse for the purposes of alimony. The alimony that is received is taxable as income to the payee spouse.
The take home point: If you are looking at paying or receiving alimony, make sure your attorney calculates the after tax cash flow of the award to find out what you are really getting or paying. It is important.
(See our article, Is Alimony Always Tax Deductible to the Paying Spouse? for detailed information.)
4. Be Wary of the QDRO Language that Divides your Retirement Assets
QDROs are the orders signed by the Judge and sent to the Retirement Plan administrator to effect the distribution of the retirement plan (think pensions). When payments are made under the plan, the former spouse who is receiving the retirement will be treated as a distributee and taxed on the amounts received.
It is imperative to discuss with your divorce lawyer the actual effect of the tax consequences of the distribution before signing off on the agreement.
5. You Can Deduct Some (But Not Most) of Your Legal Fees
Unfortunately, you cannot deduct your normal everyday divorce legal fees. However, the IRS does allow for the deduction of legal fees that occurred while getting tax advice from your divorce lawyer.
Accordingly, be sure to discuss with your divorce attorney to make sure he keeps detailed billing logs. It will be incumbent on you to prove your deduction, and you will want to report it accurately and fairly.