Happy Tax Season! Time to square up with Uncle Sam. People generally try to avoid the unpleasant subject of taxes, and it’s often on the back burner in a divorce. But failing to consider tax consequences for a divorce can be a costly mistake. Here are some points to consider:
Payments are generally includable in the gross income of the recipient and deductible by the payor. For a payment to be considered alimony, it must be made pursuant to an official divorce document, it must be made in cash or its equivalent (checks, money order, etc.), the parties cannot live in the same household, they can’t be mandatory beyond the death of the recipient spouse, and the spouses can’t file joint returns.
Also, if alimony is tied to a child-related contingency, it may not be considered alimony for tax purposes. For example, if alimony is to be reduced when the child turns 18, the IRS will say, “nope, that’s child support disguised as alimony,” and consider it non-deductible.
Finally, the parties may as part of their agreement elect not to treat alimony as includible & deductible.
Tax free: not deductible for the payor and not considered taxable income for the recipient.
Dependent Exemptions for Children
Generally, the parent who has the child for the greater portion of the calendar year has the right to the exemptions – usually the parent with physical custody. However, the parties may agree or the court may order that the parents share the exemptions equally, which is common. When the non-custodial parent claims the exemption, the tax filing must include IRS Form 8332, which requires the signature of the custodial parent releasing the exemption.
Transfers of Property
Generally, if the transfer is connected to the divorce, it’s not a taxable event, regardless of how the spouses own the property. Also, the recipient’s tax basis is the same as the transferor’s. Essentially, property transfers are treated as gifts between spouses.
Tax Law Innocent Spouse Rule
Joint tax returns create joint and several liability, which means that an error or fraud by one spouse on past returns may put the other on the hook. In some cases, however, the “innocent” spouse gets relief (they’re not so terrible at the IRS after all).