Family Law

Divorce and taxes

Even in routine divorce cases, there are income tax issues that should be addressed.  Some of the general ones 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 regular income, and therefore taxed, to the payee.  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 says 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 says 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 obligations. This potential conflict should be resolved in a separation agreement or by the court.

Under Colorado law, a parent otherwise entitled to claim the child as an exemption cannot do so if the parent is not current on his or her child support obligation, or if the parent will not benefit by the exemption.  A person's ability to receive other income tax benefits is usually tied to where the child lives most of the time.  For instance, only the custodial parent may take advantage of the following:

Head of Household
An unmarried person who maintains a home for a child for over half the year, and which is the principal home for the child, and who pays over half the expenses for maintaining the home is entitled to claim head of household status.  The person does not have to claim a child as an exemption in order to obtain head of household status.

Child Care Credit
Only the custodial parent may receive the Child Care Credit.

Earned Income Credit
Only the custodial parent may receive the Earned Income Credit.

Child Tax Credit
Only a parent who is entitled to claim a child as an exemption may claim the Child Tax Credit.

Property Exemptions

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 taxation. 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 roll them into your own retirement account.  Cashing out retirement funds will result in you having to claim those amounts as income. If the employee cashes retirement funds out, there will also be a 10% penalty.

Filing 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 a joint income tax return.  Also, do not file a joint return 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.  Talk to your accountant.