Income tax may be the last thing on your mind after a divorce or separation. However, these events can have a significant impact on your taxes. Alimony and a name change are just a few items you may need to consider. Here are some key tax tips to keep in mind if you get divorced or separated.
Tax Law Considerations
- Child Support and Alimony. If you pay child support, you can’t deduct it on your tax return. If you receive child support, the amount you receive is not taxable. If you make payments under a divorce or separate maintenance decree or written separation agreement you may be able to deduct them as alimony – but this only applies if the payments qualify as alimony for federal tax purposes. If the decree or agreement does not require the payments, they do not qualify as alimony. Keep in mind that alimony received is taxable income. Making sure to properly classify these payments can make a big tax difference, but just calling it “alimony” doesn’t make it deductible. The Tax Code specifically dictates the treatment of many items, including large upfront payments, fixed payments and payments tied to certain events.
- Tax Exemption. If the divorce decree is silent regarding the dependency exemption, it remains with the custodial parent. The custodial parent is defined as the parent who has physical placement of the child for the greater portion of the calendar. The exemption is often one of those frustrating issues with more emotional than financial significance. As much as the custodial parent does not want to give up the exemption, it is often not worth the attorney fees to litigate. One suggestion for reaching a settlement: Many states will award an exemption conditional on payments being current by the end of the year. The custodial parent may agree that getting the support on a regular, timely basis during the year is well worth the price of giving up the exemption. However, don’t waste it; if the exemption goes to a parent with not enough or too much income, the exemption may end with little or no tax benefit. Planning upfront helps allow the parent who can get the most benefit to keep the exemption. Although, you may decide one parent is better than the other to use the exemption, sometimes both parents can gain the tax beneficial “Head of Household” status.
- Asset Transfers. The general rule is that when property transfers between spouses, no gain or loss is recognized incident to a divorce. A transfer of property is incident to a divorce if the transfer occurs within one year after the date on which the marriage is dissolved or is related to the cessation of the marriage. The transfer is treated as a gift and the transferee spouse acquires the transferor spouse’s basis. Likewise, the holding period of the transferor will carry over and become the holding period of the transferee. However, the sale or transfer of the marital home requires special considerations. Timing of the sale can save the parties significant taxes and benefits. You should be familiar with the tax laws relating to the gain exclusion so the sale can effectively utilize or save the current $500,000 married exclusion. Generally, transfers of publicly traded securities pursuant to a divorce instrument result in no recognition of tax at the time of transfer. U.S. Savings Bonds are an exception. The transferor must report as income all interest on the bond that has been earned up to the date of transfer that has not been previously reported. The transferee spouse will be taxed on interest earned after the transfer, which can usually be deferred until the bond is cashed in or matures.
- Name Changes. If you change your name after your divorce, notify the Social Security Administration of the change. File Form SS-5, Application for a Social Security Card. A name mismatch can delay your refund.
Health Care Law Considerations
- Special Marketplace Enrollment Period. If you lose your health insurance coverage due to divorce, you are still required to have coverage for every month of the year for yourself and the dependents you can claim on your tax return. Losing coverage through a divorce is considered a qualifying life event that allows you to enroll in health coverage through the Health Insurance Marketplace during a Special Enrollment Period.
- Changes in Circumstances. If you purchase health insurance coverage through the Health Insurance Marketplace you may get advance payments of the premium tax credit . If you do, you should report changes in circumstances to your Marketplace throughout the year. Changes to report include a change in marital status, a name change and a change in your income or family size. By reporting changes, you will help make sure that you get the proper type and amount of financial assistance. This will also help you avoid getting too much or too little credit in advance.
- Shared Policy Allocation. If you divorced or are legally separated during the tax year, and are enrolled in the same qualified health plan, you and your former spouse must allocate policy amounts on your separate tax returns to figure your premium tax credit and reconcile any advance payments made on your behalf.
During hard times such as divorce, Reilly, Penner & Benton can work with you and your legal counsel to help make the tax pain of divorce as minimal as possible. We are here to help so don’t hesitate to contact us.
Article by: Brad Voght, C.P.A.