Divorce and Taxes
At Jacobowitz & Gubits, LLP our matrimonial and our tax attorneys work together to discuss with you and resolve the dance between divorce law and tax law. This blog will waltz you through some of the most important issues typically relating to divorce and taxes.
Filing Status. If you will soon be divorced, your filing status is determined by your marital status as of December 31st of the year for which you are filing taxes. If you are still married as of December 31, you can file your personal income taxes either jointly or separately for that year. If you file jointly that means that both you and your soon to be ex-spouse will be jointly responsible for paying any tax liabilities that are assessed. Those who choose “married filing separate” are not jointly liable because each reports his or her income separately, but instead are taxed at the highest marginal tax rate. Further, if you still live together after your divorce, you must file separately and as the “head of household” even though you still share an address with your ex.
Custody and Child Support Child support is never taxable for either the parent who pays or the parent who receives the support. Child support is considered a support obligation just as it is during the marriage. Notwithstanding, the custodial parent can claim an exemption for the child or children on his or her taxes if he or she provides at least half (½) of the financial support, unless the parent has given up his or her rights to this exemption or parents share physical custody of the children.
Maintenance. The payment of maintenance (previously called alimony) may have tax consequences to both the payer and recipient provided the following requirements are met:
1. Maintenance was awarded as part of a divorce or legal separation;
2. The parties do not file a joint tax return;
3. The spouses do not live in the same household;
4. The payments received are designated as maintenance payments; and
5. The payments are not treated like child support.
Asset Distributions on Account of Divorce. Asset distributions between spouses in a divorce are generally not taxable. Under the Internal Revenue Code (“IRC”) Section 1041 (a), no gain or loss is recognized on the transfer of assets provided these transfers occur within one (1) year after the divorce or annulment. There may, however, be transfer taxes due to New York City and New York State upon the equitable share of a marital home that is transferred from one spouse to the other. If the principal residence is sold, the person who has lived in the house for at least two out of the last five years could be eligible for an exclusion of capital gains tax under IRC Section 121.
Deducting Mortgage Payments, Interest and Real Estate Taxes. If your home is jointly owned and the mortgage paid from joint account the court assumes payments are equally made by both spouses. However, after divorce the following general rules apply:
1. If the home is jointly owned and the person who pays the mortgage and real estate taxes is not living in the home, he or she can deduct interest on the mortgage and real estate taxes on the home. The other party to the divorce (who lives in the home) may be required to then report such monthly payments as income (maintenance) but may then also deduct the interest and real estate taxes on his or her tax return; and
2. If the home is solely owned by the person who is not living in it and he or she pays for mortgage interest and real estate taxes relating to the home, then he or she can deduct everything (mortgage, interests and real estate taxes) and the person living in the home does not have to report the payments as maintenance.
Retirement Plans. If you are divorced, deferred compensation plans, and tax-deferred retirement plans such as 401(k) or 403(b) plans, may cause you unexpected tax liability. If your spouse has such benefits, your divorce settlement may require you to have a Qualified Domestic Relations Order (“QDRO”) prepared to allow you to claim a portion of your spouse’s tax-deferred benefits. When you retire and begin to draw on the benefit, you will be taxed on that income at your tax rate at that time. Please note that IRAs are not divided via a QDRO.
Tax Return Errors. The following issues can cause burdensome problems for either or both divorced spouses:
1. Unreported income. This is any taxable income received by your spouse (or former spouse) that was not reported. In addition to taxes, if there may be heavy penalties on such unreported income;
2. Incorrectly filed or prepared tax return. Often times, this item refers to any improper deduction of tax relating to that item. You and your spouse (or former spouse) will remain jointly liable for any of the above problems.
Innocent Spousal Relief. By requesting innocent spousal relief from the government, you may be relieved of the responsibility for paying tax, interest, and penalties if your spouse (or former spouse) improperly reported items or omitted items on your joint income tax returns. The result is that the tax, interest and penalties that qualify for relief can only be collected from your spouse (or former spouse). If you do not qualify for innocent spousal relief, you remain jointly and individually responsible for any tax, interest and penalties. You must meet all of the following conditions to qualify for innocent spouse relief:
1.You filed a joint income tax return, which has an understatement of tax due to erroneous items of your spouse (or former spouse);
2.You establish that at the time you signed the joint income tax return you did not know, and had no reason to know, that there was an understatement of tax;
3.It would be unfair to hold you liable for the understatement of tax.
A request for innocent spouse relief will not be granted if the IRS establishes that you and your spouse (or former spouse) transferred property to one another as part of a fraudulent scheme. A fraudulent scheme includes a scheme to defraud the IRS or another third party such as a creditor, ex-spouse or business partner.
We hope that the above discussion helps you with that part of divorce that is often times difficult to understand. After reviewing this blog, should you have a different or unique question not addressed herein feel free to give us a call for purposes of discussing same.
Mark A. Krohn, a partner, is in charge of the Business Law Team and is also a member of the Trust & Estates Team. He can be reached by phone at our Walden, NY office at 866-303-9595 toll free or 845-764-9656 and by email.