Going through a divorce can be a dramatic and trying time. Issues such as division of property, custody of children and family support are huge. And the decisions made to resolve these issues have a tax impact. It is important to know how you will be affected and take steps to minimize your tax liability.
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The IRS doesn’t make it an easy chore. Even determining filing status can be complicated. A good rule of thumb is that your marital status at the end of the year determines your filing status.
If you are still married at the end of the year, in other words the divorce is in process but not yet final, you can still enjoy the tax benefits of filing married filing joint. However, you must both agree to this filing status. Otherwise, you will file married filing separate, which normally results in a higher tax to each filer but will protect you from the other spouse’s tax liability.
Taxpayers lose many benefits when electing the filing status of married filing separate. For example, both must elect to either take the standard deduction or itemize deductions. This could skew in favor of the spouse who is able to take the deductions when itemizing. For example, the spouse who is making the house payment will enjoy the mortgage interest deduction, usually a substantial write off. The other spouse will get zero. Other benefits lost by both parties include the American Opportunity Credit and Lifetime Learning Credit (for higher education), tuition and fees deduction, and student loan interest. Dependent Care Credit and Earned Income Credit may also be affected.
If filing joint, the marital separation agreement (MSA) will not protect you from the IRS on the issue of tax liability. The IRS holds both parties signing a joint return responsible for the tax liability even if the MSA states one spouse or the other must absorb the expense. The IRS expects payment and will seek payment from each spouse and let you duke out with each other in court later on. So if the tax is not paid, they can easily garnish wages and levy bank accounts of both parties.
But let’s say you file jointly and enjoy a refund. The IRS provides Form 8379 Injured Spouse Allocation to determine how the refund should be fairly split.
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Your tax professional can run the tax return under either filing status to determine the additional tax liability, if any, and advise you on the best way to file.
You may also be eligible to file as Head of Household even if you are still married, which is an advantageous tax bracket. But you must fall within these requirements:
- You paid more than half the cost of maintaining your home during the tax year
- If still married, your spouse did not live in the home during the last six months of the year
- The home must be the main home for you and at least one child, step child or foster child for more than half the year
- You must be either unmarried or considered unmarried on the last day of the year
You cannot file head of household without a qualifying person in the picture. And that qualifying person is usually a child. A new boyfriend or girlfriend or roommate does not qualify a person for this filing status.
The only way you can file as single is if you have a settlement agreement and a final decree of divorce or if you were awarded a decree of annulment. This normally applies to divorced couples without children.
It is important to discuss the tax implications of divorce with your tax professional and determine a plan and course of action that benefits your tax situation. Next week I will discuss dependency exemptions, child support, and alimony.