Divorce is already one of the most stressful life events that many of us will go through. There’s a reason the expression is “going through a divorce”–it is truly a process to be endured. There are many factors to consider when you find yourself separating from your partner. On top of the emotional stress involved, you will also have legal and tax concerns to worry about. One concern is the fact that family courts often make rulings that directly conflict with federal tax law.
Technically, federal tax law trumps family court rulings. But in practice, this does not stop judges from making rulings that run counter to federal tax law and can spell trouble for the taxpayer. The errors in these rulings tend to arise out of ignorance. Family court judges may be accomplished experts in the practice of family law, but that does not mean they are also experts in federal tax law. The unfortunate result is that many judges inadvertently create tax problems for the divorcing couple. Further, if your family lawyer is not familiar with your potential tax issues, he or she may not be able to advocate for you as effectively. Fortunately, you can avoid the complications we will discuss by simply being aware of them and using the appropriate kind of professional help. Read on to learn some of the most significant tax issues you are likely to face in a divorce, and more importantly, what you can do to prevent the most common tax problems associated with divorce.
Dependency Issues: Which Parent Gets to Claim the Child as a Dependent?
One of the most common issues that a divorcing couple with children may face is who gets to claim any children as dependents on their federal tax returns. The parent who uses this exemption may be eligible for up to $4,000. Family court judges often mistakenly believe that both parents may claim a dependency exemption, particularly in cases where they are sharing custody. This simply is not true, and a person who blindly follows the court’s ruling may later find they owe the Taxman, despite having done “everything right” per the ruling.
Which parent has the right to claim dependency isn’t always clear-cut. Most courts will award the exemption to the custodial parent, or the parent who is providing over half of the child’s support and care. In joint custody cases, the determination of who is providing the majority of care will be made by the family court.
However, there is an exception to this general rule. The custodial parent may choose to release the exemption to the other parent by filling out IRS Form 8332 and submitting it with his or her tax return. Since all family situations are unique, this may be appropriate in yours. But be advised that if you elect to release the dependency exemption, you will not be able to claim the Child Tax Credit of up to $1,000 either.
Child Support Issues
Child payments may not be deducted or taxed, regardless of which party is awarded child support. The legal basis for federal tax law treating child support in this manner is interesting. The short version is that Uncle Sam does not want to incentivize or promote divorce in any way, and that allowing for any kind of potential tax break surrounding child support may do exactly that.
Alimony is a type of income and is therefore considered deductible for the party making payments. The payer may deduct however much alimony the payee is claiming as income on his or her tax return.
Some divorcing couples opt to use unallocated income as an alternative to alimony. This option is considered legally distinct from either child support or alimony, and may confer some additional benefits to both parties. First, contingencies may be placed on the support payments that are directly related the the costs of childcare and the circumstances of both parents and the child. For instance, unallocated income may end if your former spouse gets married, your child reaches a certain age, or in other scenarios. There may also be tax benefits for the divorcing couple, such as the recipient of unallocated income paying in a lower tax bracket for the support received.
A wide variety of property issues may affect your tax situation during the divorce process. Some concerns real estate investors would be wise to advise their tax and legal professionals about may include the following:
- Property transfer issues. Married couples may make property transfers to one another tax free. However, once the divorce is finalized, taxes would come into play.
- Tax status of properties. A fairly common scenario is dividing cash assets and real property. However, when making these determinations, take into consideration that the spouse who takes property over cash assets will also be liable for paying taxes on the property if it is sold.
- Investment properties and method of ownership. If you and your spouse were making real estate investments together, disentangling your investments from one another and determining what is rightfully yours can present its own challenges. Spouses who own property using tenancy-by-the-entireties (TBE) should know that the TBE agreement is nullified in the event of a divorce. While you would need your spouse’s permission to sell your homestead property–the only type of property that may be owned TBE–during the marriage, you would not need their consent following divorce. Note that the agreement is nullified as soon as either spouse even files for divorce.
If you anticipate any of the above property issues, one practical step you can take to make things easier is to make a complete list of any and all assets you own.
Other Tax Considerations in a Divorce
Many of the other issues to consider when divorcing are directly affected by which parent receives the dependency exemption. Examples of these issues include:
- Education Credits. Tax credits for college tuition are automatically awarded to the parent who claims the dependency exemption. This holds true even if the other parent is paying a larger portion of the student’s tuition.
- Child Care Credit. Again, the custodial parent (i.e. the one receiving the dependency exemption) is the only parent allowed to claim tax credits for costs related to childcare. If you are sharing custody, advise your tax professionals of this situation.
- Conflict of Interest. However, if you and your soon-to-be-ex-spouse share a tax professional, that same professional cannot represent both of you during the divorce. The same is true of attorneys. In both cases, the same professional representing both sides in a divorce proceeding would be considered a conflict of interest, which is a violation of professional ethics.
Avoid Tax Complications With Your Divorce By Getting a Professional’s Opinion
Fortunately, the issues discussed above can be prevented with a little bit of education and the help of competent tax professionals.
If you’re an investor preparing for a divorce, feel free to contact Royal Legal Solutions with questions you have about protecting your real estate assets during the process, avoiding tax issues, or any other concerns relating to your real estate investments. Our legal professionals are familiar with the tax laws affecting real estate, and we also maintain relationships with competent CPAs who can assist our investor-clients. We can also work with your family law attorney to ensure your needs will be advocated for properly in any divorce or custody proceedings. Whether your concerns are about taxes or other issues that require a sensitivity to the needs of real estate investors, Royal Legal Solutions can help you. Stay ahead of any potential legal issues by scheduling your personalized consultation today.