Few people relish the thought of dealing with tax issues but there are five things you need to know about taxes BEFORE you divorce.
These are some very basic, elementary issues that affect most of us and yet people, especially those people who are trying to do their own divorce without attorneys, often don’t think about these issues ahead of time and then just accept the boilerplate language or worse, don’t address these issues in their divorce agreement. Neglecting these issues will almost certainly necessitate more negotiations in the future with your ex and could lead to scrutiny from the IRS and no one wants that!
Joining me for this Conversations About Divorce is Certified Divorce Financial Analyst Shawn Leamon. Shawn is the host of the podcast Divorce And Your Money and author of the book Divorce And Your Money. Listen in or keep reading …
How Is My Tax Filing Status Determined?
First, there are four relevant filing statuses to choose from: Married Filing Jointly, Married Filing Separately, Single, and Head of Household.
“Each filing status has benefits and advantages both from a tax perspective and how your divorce is proceeding,” said Leamon.
Your tax filing status is determined by your marital status on December 31. That means if your divorce becomes final on December 31 in the current year, you will not be able to file as married for the current year.
Whether that’s good or bad depends on your tax situation and if a change in status would mean paying more or less in taxes. You could try using an online program like TurboTax or H & R Block to see the difference a change in tax filing status would make. If you do work with an accountant, check with them.
Armed with this information, you can make a conscious decision about when to file for divorce or if you can, you can request the court to delay making your divorce final. In Colorado, for example, there’s a minimum period of 92 days between filing and your divorce becoming final. Knowing this, and let’s assume you and your STBX have got all your paperwork figured out, instead of filing in September with the prospect of being divorced in December, you might decide to hold off filing until early October so there’s no chance of losing that married filing status for the current year.
Should I File Married Filing Separately?
Leamon says that the married filing separately status is rarely used.
“Under normal circumstances, even under divorce, if you are married you file jointly because it will lead to the lowest tax bill,” said Leamon.
There are however times when you should file separately. “If you sign your name to a tax return, you are saying the information is accurate and you are responsible for the outcome,” said Leamon.
If you think your spouse is doing something illegal, fraudulent, is hiding money or is involved in a questionable business, then you may wish to file separately. Another circumstance is if you think the information is simply wrong.
If you are going to file separately, then you will need to tell your STBX and that likely will not be an easy conversation.
Can I File Head of Household?
Filing Head of Household gives you a bigger tax break than filing single and simplistically, it’s available if you provided a home for your child for more than half of the year.
Leamon who’s based in Texas, says that in most of the cases he works on, one parent is regarded as the primary custodial parent and so that parent gets to file Head of Household.
If you have one child together, then you can’t both claim Head of Household. It’s one or the other in any specific tax year although you could agree to alternate years and you will want to be clear on that in your divorce agreement.
If you have two children, then you could both file as Head of Household if you both meet the IRS criteria.
Leamon also sees who claims Head of Household status being negotiated because there are often exceptions and reasons to vary from the norm. “You can structure things however you like. You just have to make sure it’s well communicated as part of the settlement,” said Leamon.
How Does The Child Tax Exemption Work?
The child tax exemption is separate from filing status. The IRS gives a tax exemption for each child. But there is only one exemption per child and in any one year it can’t be split or shared. That means that either you or STBX can claim the exemption. If you both try to claim it, one of your returns will be rejected by the IRS and again, that’s a problem you likely want to avoid.
The way to avoid this is to come to a clear, written agreement during your settlement negotiations on how you will handle the child exemptions going forward. And again, there are many choices.
If you are communicating well and are confident that will continue, you could for example agree that you or your accountant will determine who will benefit most from taking the exemption each year and then that person will provide some sort of compensation to the other in exchange for the exemption.
Most people however, prefer a cleaner break. “You’re getting divorced for a reason. Imagine having to go back to your STBX each year. What if they are non-responsive and that’s holding up your taxes?” said Leamon.
For couples with one child, a typical arrangement is to simply alternate who claims the exemption each year.
For couples with two children, a typical arrangement is for each adult to claim one exemption and then when the child no longer qualifies for an exemption, they alternate.
The most important part though is to make sure your settlement agreement is specific and clear about who can claim the exemption.
What Happens To Taxes And Refunds Due?
This is another often overlooked detail. Your settlement agreement needs to specify how any amounts due to the IRS and any refunds are going to be handled and that can be tricky if say for example, you’re filing in September and you won’t be doing your current year taxes until February, March time.
Given the uncertainty, it’s difficult to specify who’s responsible for what in dollar amounts but you can specify a percentage share for how these should divided. Before you do that, it’s a good idea to check how each party’s withholding to date compares to IRS calculations. You likely don’t want to be agreeing to share 50/50 in amounts due only to find out next year that your STBX has been under-withholding.
And do pay attention to where you’re telling the IRS to send any refunds. Getting a refund re-processed because the bank account you gave to the IRS has been closed as part of the divorce could take months. Similarly, telling the IRS to send a refund electronically to your STBX’s account could mean difficulties getting your share.
Shawn Leamon is a CDFA and author of Divorce And Your Money. Learn more about Shawn at his blog.