Yeend, Castaneda & Flynn, LLP

For most taxpayers, determining the tax consequences that can arise during a divorce or marital separation can be vital for the financial protection and well being of you and your family. It is important to understand applicable tax laws before making major decisions.

 

Alimony

Generally, alimony is the amount paid to a spouse for his or her living expenses, education, etc.

Alimony is not for providing child support.

The person receiving alimony is called the "payee spouse," and the person paying alimony is called the "payor spouse."

 

The payee spouse must pay taxes on the alimony in the year it is received, and the payor spouse may deduct the amount in the year it is paid, provided the alimony meets all of the following conditions:

The payment is made in a cash form, which includes checks, bank deposits, etc. Payment in the form of such things as bonds, stocks, money market shares, or actual objects are not considered alimony for tax purposes.

The payment is made as the result of a legal separation agreement or divorce decree.

The payor spouse and payee spouse do not live in the same household at the time the payment is made.

The divorce instrument does not designate the payment as nontaxable to the payee spouse and nondeductible by the payor spouse.

The payments are not "fixed" (or treated as "fixed") as child support.

Note: There is no liability for payments after the death of the payee spouse

 

Child Support

Child support, unlike alimony, is not taxable to the payee spouse, nor is it tax deductible by the payor spouse. This is true regardless of how the payment is described in the divorce papers.

A divorce decree may specifically call a payment "alimony," but the payment may have the "characteristics" of child support.

One characteristic of a child support payment might be the designation in the divorce document that the payment be terminated if the child's situation changes.

If the payment appears to be more characteristic of child support than of alimony, the payee spouse will not pay taxes on it, and the payor spouse will not deduct it, despite what it's called in the divorce papers.

 

Dependency Expemption: Who claims the childs dependency exemption when a divorce occurs?

For a taxpayer to claim another person as a dependent for tax purposes, the following conditions must be met:

Relationship test - The dependent must either be related to the taxpayer or be a member of the taxpayer's household for the entire year.

Citizenship test - The dependent must be a U.S. citizen or resident, or a resident of Canada or Mexico for some part of the tax year.

Joint return test - In general, if a dependent files a joint tax return, an exemption is not allowed.

Gross income test - An exemption is usually not allowed for a dependent if that dependent has a gross income that is equal to or greater than the "exemption amount" for the tax year.

Support test - For children of divorced or separated parents, more than half of the child's support must be furnished by one or both parents.

 

The custodial parent (the parent who has physical custody for a greater portion of the year) is generally treated as the parent who provided more than half the child's support and is awared the dependency exemption. It is possible for the custodial parent to transfer the exemption to the noncustodial parent. To do so:

The custodial parent either files Form 8332, Release of Claim to Exemption, or a statement that contains the required information (such as the divorce decree).

The release of claim by the custodial parent can be made for only the current year, for a specified period of time, or for all future years.

Special rules apply for parents who were never married to each other. You must provide more than half the support of your child or enter into a multiple support agreement to satisfy the support test.

 

Property Transfers

There is typically no gain or loss on the transfer of property from one spouse to another (or to a former spouse if the transfer is "incident to divorce").

This rule applies to both separate and community property in divorces that occurred after July 18, 1984.

If a transfer is to be considered "incident to divorce," it must occur within one year of the divorce date, or must be made according to the terms of the divorce or separation document, and not more than six years after the divorce date

Because there is no gain or loss recognized at the time of the transfer, the basis of the property received is not adjusted, even if the transfer is part of a bona fide sale at the fair market value.

 

Attorney Fees

Legal fees paid to obtain a divorce are usually not deductible for tax purposes.

Fees paid in connection with the collection of alimony or other income­ producing property are deductible.

 

Related Issues

If a joint tax return is filed, both the husband and wife can be held jointly and individually liable for the tax due, as well as any interest and penalty related to the joint tax return, without regard to what is stated in the divorce decree.

A distribution from a retirement plan combined with a subsequent rollover (by the other spouse) without a "qualified domestic relations order" (QDRO) can cause a penalty for both taxpayers.

For purposes of the child care credit and the earned income credit, a child of divorced or separated parents is treated as a qualifying child of the custodial parent.

The above is true even if the noncustodial parent can claim the child as a dependent.

The parent who claims the child as a dependent also claims the child tax credit.

The parent who is eligible to claim the child as a dependent is eligible to claim the Hope/Lifetime Learning Credit.

For education credits, this is true regardless of which parent paid the tuition.

Since July 19, 1998 , a Separate Liability Election is allowed, which limits your liability for tax, interest, and penalty on the tax liability allocated to your former spouse on a joint return.

 

Summary

Tax challenges during and following a divorce are common, but they can be minimized with some knowledge about tax laws and IRS procedures. Financial planning is an important part of the divorce process. As always, see your tax advisor for additional information and answers related to your specific situation.

 

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