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Taxpayers scurry to gather all of the important tax documents in the weeks and days leading up to April 15th. Many do little or no tax planning. But, some life-changing events, such as divorce, may require more thought. There are several tax consequences of separation and divorce that must be carefully considered by all parties.

Filing Status

Filing status, for tax purposes, depends on the taxpayer’s marital status on the last day of the tax year. Taxpayers are generally considered to be married if they are separated, but have not yet obtained a decree of divorce. In some circumstances a taxpayer may file as head of household if still technically married, but “considered unmarried.” You are “considered unmarried” on the last day of the year if all of the following requirements are met:

– You file a separate return.

– You have paid more than half of the costs to maintain your home.

– Your spouse did not live in the home for at least six (6) months preceding the last day of the year. You can be disqualified if the spouse is merely “temporarily” absent.

– You have maintained the main home for your child for over half of the year.

– You properly claim an exemption for the child. (However, you may qualify for head of household even if you are unable to claim the exemption because the noncustodial parent claims the exemption instead, pursuant to a special rule discussed later.)

Itemized Deductions
Divorced clients often have concerns concerning itemized deductions. If separate tax returns are filed, some itemized deductions may be split between former spouses. These deductions include medical expenses, state income tax, property tax, mortgage interest and casualty insurance.

Another common concern is which spouse can take the deduction for children of the marriage. If a child meets the tests to be a “qualifying child” by more than one parent (for example, when parents are separated or divorced), only one parent may claim the exemption. The general rule is that a “qualifying child,” or a child that is the subject of a proper dependency exemption, is one who lives with the taxpayer for more than half of the year. There is, however, a special rule for divorced or separated parents and a noncustodial parent may claim an exemption for their child or children if certain requirements are met.

Equitable Distribution
Equitable Distribution, the division of property in connection with a divorce, raises several tax concerns. For one thing, Equitable Distribution may require liquidating assets. If the taxpayer must sell a home to make a distributive award, for example, capital gains taxes may be incurred. Capital gains taxes are incurred on the sale of a home that is not your primary residence, or if the sale generates profits above a certain amount. The latter has been less of a problem in the down economy of recent years.

Also, it often happens that parties’ retirement accounts are divided during Equitable Distribution. Generally speaking, a participant in a plan faces severe penalties if he or she tries to transfer or withdraw funds prematurely; however, there are mechanisms to avoid such tax penalties on the distribution of retirement accounts. One such mechanism is a Qualified Domestic Relations Order (“QDRO”).  A QDRO is an Order that recognizes the existence of rights of a spouse or former spouse to the benefits of a qualified retirement plan, that is, one governed by ERISA (the Employee Retirement Income Security Act). Note that retirement benefits paid directly to a spouse or former spouse by way of a QDRO, while not subject to a tax penalty, are generally includible in the recipient’s income. Rollover distributions paid by QDRO into the recipient’s IRA or other retirement plan may, on the other hand, be a tax free event until such time as the spouse starts taking distributions out of the plan.

Alimony and Child Support
So long as several conditions are met and the alimony is structured to comply with the requirements of the Internal Revenue Code, alimony is deductible by the payee and is includable in income to the recipient. Alimony can be deducted even if the taxpayer does not itemize their deductions. Child support on the other hand is a non-taxable event. It is not deductible to the payor, nor is it considered income to the payee.

This is just a small preview of some of the most common tax issues that arise in the course of a divorce. Seek the advice of experienced counsel to help you manage these and other tax issues incident to divorce.