Divorce and Taxes

(Everyone’s Two Favorite Things!)

No one wants to think about this unless they have to, but if you are facing a divorce there are some very important things you want to think about regarding your financial planning and responsibilities. Taxes are already stressful and divorce even more so – combine the two and sometimes people would rather avoid the whole conversation. Divorce is a touchy subject but that doesn’t mean it should be ignored in your family’s tax planning. Hopefully, both parties can agree to work together to ensure maximum refund dollars stay with the family rather than overpaying taxes.

We recently had a set of parents come to see us about filing their returns after their divorce. The court instructed the couple to file their tax return with the husband claiming all mortgage interest, real estate taxes and both of their children.  But, because of his high income, the house expenses were actually costing him more in Alternative Minimum Tax (AMT) and the education credit of $2,500 for their son in college was eliminated altogether.  After carefully reviewing the two tax stories, we came up with a plan that saved them over $7,000! Had they simply follow what was suggested by the judge, they would have really missed out. It just serves as a reminder that courts and judges aren’t tax or financial management experts and their advice could not be what’s best for your family as a whole.

How should we file if we are separated but not fully divorced? 

In most cases, it’s best to continue to file jointly if you are separated during the years prior to divorce. In the eyes of the government, you are still married, and, in most circumstances, you’ll pay less in taxes overall when filing jointly so stick with it.

My spouse is a business owner – does that change anything?

If you or your spouse is a business owner, the other person carries a certain amount of liability. It typically takes 2-3 years after filing for the government to issue an audit. If the company were to be audited the now ex-spouse would also be on the hook for the duration of the audit and any additional monies owed to Uncle Sam. 

We got divorced late in the year – how does the government view our marital status for tax filing?

If your divorce is final prior to December 31st of that year the government considers you divorced for the entire tax filing year. It’s the same when you get married. The government considers you married for the full year as long as you were legally married before December 31st.

We have kids – how do we handle claiming them to get the most tax benefits possible?

If you both make relatively similar incomes and are sharing the responsibilities of raising the kids, you want to plan on dividing the children so each parent claims an equal number of children on their tax return and alternate years with the last child if you have an odd number.  This strategy offers more consistent refunds which we’ve found favorable for financial planning and reducing the stress around taxes. However, the more complex your income picture is the more we recommend working with a professional to create the best strategy for your family. If you don’t have consistent tax filing circumstances or if you don’t have professional support, it’s hard to plan your withholdings. Keep in mind, if you are accustomed to claiming children and one year you don’t, you need to make sure you proactively increase your withholding throughout the year, so you avoid tax surprises.

How are child support and alimony reported?

If you pay child support we’re sorry to say this isn’t viewed as a deduction on your taxes and your ex doesn’t need to claim it as income. It’s considered a personal expense. If you were buying groceries or shoe shopping for your child, you wouldn’t expect to deduct that money. Technically, the money is being used in the same way only by the other parent and not directly by you.

Alimony tax laws have recently changed. If you were divorced prior to January 1, 2019, then alimony is viewed as a way to balance out the earnings of two people after divorce. If you are the payer, then you can deduct the alimony amount from your income. If you are the payee, you need to report this money as part of your income. However, under the new tax law anyone who divorces after January 1, 2019, can no longer deduct alimony that is paid out and is no longer claimed as income if received.

We have large assets that we both own – how should we handle them?

Folks with large assets like rental properties could be in a world of hurt if one partner were required to buy the other out. Unfortunately, if it comes down to this, it’s common to be forced to sell the asset if it can’t continue to be managed amicably. Even though you are in the process of separating your life from this person you could be hurting both of you financially in the process. Selling something at the wrong time in the market could mean taking a big hit financially. Or, you could be getting rid of a cash cow just because you can’t agree. In cases like this, before you make a decision that hurts you both, in the long run, we highly recommend seeking out a collaborative divorce lawyer or financial advisors to help you navigate these larger assets for the best possible outcome.

An amicable divorce can help your family in many ways and effectively managing taxes is no different. If you head to court and let a judge dictate how your finances are handled you are almost certain to lose money overall. The best possible option is to work with an accountant to evaluate the best approach. We know all about collaborative divorce and would be happy to work with your team of advisors to ensure the best interest of your family. If you are facing a divorce, don’t wait until tax time to have all this sneak up on you – schedule a time to meet with us so we can strategize and help you understand the impact on your family’s finances.

If you are looking for more information, download our divorce and taxes handout! 

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