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Divorce and Taxes
Even in routine divorce cases, there are income tax issues that should be addressed. Some of the general issues are listed below. If you have a complex marital estate, you should speak with your tax advisor during the divorce process. Maintenance (Alimony) and Child Support Maintenance is considered regular income to the person receiving it, and therefore taxed. Maintenance payments are tax deductible by the person who pays maintenance. Child support is not taxable, and payment of child support cannot be taken as an income tax deduction. Dependency Exemptions Federal law states
that the person who lives with a dependent for the majority of the time is entitled to claim the dependent and receive the dependency exemption on income tax returns. Colorado law states that a dependency exemption is allocated between parents in proportion to their contributions to the costs of raising the children (usually understood as in proportion to parents’ child support obligation). However, under Colorado law, a parent otherwise entitled to claim the child as an exemption cannot do so if that parent is not current on his or her child support obligation, or if the parent will not be benefited by the exemption. A person’s ability to receive other tax benefits is usually tied to where the child lives most of the time. For instance, only the person who claims the child as an exemption can take advantage of the child care credit and the child tax credit. Head of Household: An unmarried person who maintains a home for a child for over half of the year, and which is the principal home for the child, and who pays over half of the expenses for maintaining the home is entitled to claim head of household status. The person does not have to claim a child as a dependent in order to obtain head of household status. Child Care Credit Only the person who claims the child as an exemption may receive the child care credit. Earned Income Credit Only the parent who claims the child as an exemption may receive the earned income credit. Property transfers Property transfers between spouses or ex-spouses made incident to a divorce are tax-free transfers. However, the person who is awarded an asset incident to a divorce takes that asset with no step-up in basis. Therefore, it is important to know what the basis in a particular asset is, in order to factor taxes into the property distribution equation. If a person has lived in his or her primary residence for 2 of the last 5 years, and the residence is sold, the first $250,000 of gain for individuals and $500,000 of gain for married persons is excluded from tax. If one person is going to retain the family home after a divorce, and there is likely to be more than $250,000 of gain when the home is ultimately sold, parties should address the tax implications during the divorce process. Cashing out retirement funds If you are awarded a portion or all of your spouse’s retirement funds, it is best to keep the funds where they are, or to directly roll them into your own retirement account. Cashing out retirement funds will result in you having to claim those amounts as income, and a penalty. You can lose upwards of 40% of the money in tax and penalties.
However, an alternate payee may cash out some retirement funds with no
penalty. Still, the alternate payee will be taxed. Filing Tax Returns Together It is usually the case that filing joint tax returns when you are married will result in less tax being paid than filing separately. You may file joint income taxes so long as you were married on the last day of the year. However, when you file a joint return with your spouse, you are 100% liable for 100% of the tax due. If you are concerned that the tax due will not get paid by your spouse, you may not want to file joint income taxes. Also, do not file joint income tax returns if you believe your spouse does not fully report income, or is otherwise committing tax fraud. Deductibility of Legal Expenses A portion of your divorce related legal expenses may be deductible, if your attorney gave you tax advice,
or representation was related to determination of spousal maintenance. Talk to your accountant.
Tax Links of Interest
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