As you initiate your divorce action, annulment proceeding, or legal separation, your tax filing status does not automatically change. However, as your case proceeds through the legal process, you should consider a number of tax filing options and some rules governing taxable income and deductions. You are only considered “unmarried” for tax filing status if your final decree of divorce or legal separation entered by the last day of the applicable tax year and you did not remarry thereafter in that same tax year, or if your annulment decree has been entered. If it is after the first of the new taxable year, and no decree of divorce or legal separation was entered by December 31st of the preceding tax year, then you do not have the option of filing your tax returns under “single” status. Likewise, if the annulment decree has not been entered, you cannot file a single status return. Your choices are only married joint or married separate, and possibly “head of household.”
Married Filing Jointly
During your divorce case, you and your spouse can file your tax returns as married filing jointly. Under this filing status, you report all of your income together. This allows you to claim all the exemptions, deductions, or credits to which either or both of you are entitled, without limitations or restrictions that are applicable to “married filing separately” status.
In deciding whether to file jointly, consider not only the resulting tax liability but the ramifications of being jointly and severally liable for the taxes, penalties, and interest of your spouse. Because your divorce is still pending, you must consider the overall tax implications. In most jurisdictions, an income-tax liability owed during the marriage, as well as a tax refund, are marital and subject to division by the divorce court. The marital estate as a whole will benefit from the overall lower tax. To find out what is best in your case, calculate taxes for you and your spouse, based on married filing jointly, as well as married filing separately. Then compare both scenarios to see which is best.
Remember, the lowest tax is not the only consideration. You must balance taxes due against your risk of being jointly and separately liable for taxes, interest, and penalties on a joint return. If you question whether your spouse is reporting all income, or have little or no knowledge of your spouse’s income and finances, discuss this issue with legal counsel before signing a joint return. The Internal Revenue Service (IRS) can hold you liable for all taxes due on a jointly filed return, as well as penalties and interest, even if your spouse alone earned the underlying income. Relief is available from this joint liability, including innocent spouse relief, separation of liability, and equitable relief. However, any relief will be based on the facts of your case, so talk with your attorney about any issues of concern. Your attorney can explore whether any of the joint-liability relief would apply to you.
If you have a temporary alimony order in your case, the court-ordered payor may be able to deduct the alimony payments. Conversely, the court-ordered payee may have to report the alimony as taxable income. However, if you file “married joint,” there is no tax benefit or tax obligation to court-ordered alimony. Therefore, in deciding whether you and your spouse file “married joint” or “married separate,” an alimony award must be considered as part of the overall tax effect to the marital estate. If one spouse had no gross income during the tax year, the other spouse who had gross income may file “married separate” and claim his or her own personal exemption as well as the other spouse’s. To do so, the spouse who earned no gross income must agree not to file a return at all, and he or she may not be a dependent of another taxpayer.
Married Filing Separately
If your divorce or legal separation was still pending as of December 31st of the tax year for which you are filing, or your annulment decree has not yet been entered, you do have the option to file your taxes as married filing separately. Under this filing status, you report only your own income. You can qualify for this filing status even if only one spouse had income during the tax year. Benefits of filing under this status include only having liability for the tax, interest, and penalties on your own return. The IRS would not pursue you for your spouse’s tax obligation for that same year.
Unfortunately, there are limits to exemptions, deductions, and credits when you file “married separate.” You cannot claim your spouse’s exemption on your separate tax return if the other spouse earned income or is filing a tax return or is a dependent of another taxpayer. Be careful if you pay temporary alimony to your spouse because that is income to the recipient, which is one of the disqualifying factors in claiming a spouse on your return.
Likewise, you and your spouse cannot both claim an exemption for the same dependent child. Depending on your state laws, your divorce court may be able to enter temporary orders on who gets to claim the child’s exemption on separate tax returns filed during the divorce action. In the absence of such orders, the IRS does have some guiding principles. You can claim the child’s tax exemption if the child lived with you for the greater part of the year. If you, your spouse, and the child resided together for part of the tax year, you can still claim the exemption for the child if, after you and your spouse separated, the child lived longer with you for the balance of the tax year. If the child did not reside with you for most of the tax year, but you and your spouse lived apart for the last six months of the tax year, you still can claim the exemption if the other parent (with whom the child lived for most of that time) signs a written statement (Form 8332 or a similar statement), stating that he or she will not use the exemption. This needs to be attached to your tax return at the time of filing. Finally, as is a common factual complication, if the child lives with each parent for equal parts of the tax year, the parent with the higher adjusted gross income is entitled to claim the child.
If filing “married separate,” and your spouse itemizes his or her deductions, you likewise must itemize your deductions and you may not use the standard deduction, even if doing so would have resulted in a more favorable tax outcome.
Another matter is who gets which itemized deductions. For example, if qualifying
medical expenses were paid from a joint account in which spouses have
an equal interest, usually each spouse is entitled to deduct on separate
returns one-half the total medical expenses as itemized deductions. But,
if you own a qualifying home as “tenants by the entirety,”
you can only claim property taxes and mortgage interest that you alone
paid. Even if you and your spouse both use
the standard deduction, the amount of that deduction under married filing separately is less than under married filing jointly.
Tax credits also are more limited under this filing status. For example,
usually neither spouse can claim the child and dependant care expenses’
credit, nor the earned income credit, nor the higher education expenses’
credit. The tax rates increase at lower income levels for “married
separate” filers, compared with “married joint” filers,
and your capital loss deduction is less. As a result of these and other
limits on exemptions, deductions, and credits, married filing separately
usually equates to higher taxes.
If you are receiving court-ordered temporary alimony or spousal support, such payments may be taxable to you on a separate return. Similarly, if you are ordered by the court to pay temporary alimony, those payments may be deductible on your return. For the alimony to be taxable/deductible, payments must be made pursuant to a court order, be in cash, not be designated as nontaxable/nondeductible, not treated as child support, and they must end at the recipient’s death. Given these requirements, it is best to consult with your attorney to determine whether yours is taxable/ deductible alimony.
There are less obvious court-ordered indirect payments that can be considered temporary alimony for tax purposes. For example, if you are court ordered to pay your spouse’s medical expenses, rent, and utilities, these payments can be treated as received by your spouse and then paid to a third party, and so deemed alimony. If your spouse is ordered to pay premiums on a life insurance policy (insuring his or her life), to the extent that you own the policy, those premiums can be deemed taxable to you. Or, if you are ordered to pay expenses on a jointly owned home, even some of those payments may be deemed alimony and the deductions limited. For example, if you are ordered to pay mortgage paymentson the jointly owned home, and other characteristics of alimony are present, half of the total payments can be deductible by you and taxable to your spouse. However, you may claim only one-half of the interest paid as an itemized deduction.
Head of Household
If your decree of dissolution of marriage or legal separation is entered before the last day of the tax year, or the decree of annulment is entered before you file your return, you may be able to file your return as head of household if other requirements (detailed below) are met. Even if your decree has not been entered and your case is still pending, you may be eligible for head-of-household filing status if your spouse did not live in your home for the last six months of the tax year. This is an attractive alternative, as you do not have the joint liability that comes with married filing jointly, and the exemptions, credits, and deductions are not as limited as when you file “married separate.”
The other basic requirements for this filing status are that you paid for more than 50 percent of the upkeep of your home, including rent/mortgage, taxes and insurance, repairs and maintenance, utilities, and even groceries; your home was the main home of your child, even stepchild or foster child, for more than half of the year; and you are eligible to claim an exemption for the child, even if you sign the exemption waiver to allow the noncustodial parent to claim it. Other qualifying persons, such as a grandchild, parent, grandparent, or sibling for whom you provide care can provide a basis for you to claim head of household, so discuss your specific facts with your lawyer.
If you meet the requirements for this filing status, you can itemize your deductions or elect the standard deduction, whichever you choose, and regardless of what your spouse chooses. The standard deduction is higher than if you file “married separate,” and your tax rate will probably be lower under this filing status than under “married separate.” You also would be able to claim credits, such as dependent care credits and the earned income credit, which otherwise are not available to you under married filing separately. Your entitlement to exemptions is the same under headof- household filing as it is under married filing separately. The temporary alimony issues and considerations are also the same.
You can only file your income tax return under the single status if your final decree of dissolution of marriage or legal separation is entered by the last day of the tax year and you did not remarry in the same tax year, or if a decree of annulment has been entered. As to the divorce or legal separation decree, if the decree is entered, even on the very last day of the tax year, December 31st, the IRS deems you unmarried for the entire tax year. This can be a crucial planning step in your divorce. Many a judge is in chambers on New Year’s Eve day signing decree after decree to trigger the change in filing status.
Annulment means that no valid marriage ever existed. So not only must you file your taxes as single, or head of household if you otherwise qualify, but you must also amend any prior married-filing-separately or married-filing-jointly returns. Some returns may be time-blocked for amendment, usually those filed more than three years prior. Speak with a tax adviser about how many preceding tax years’ returns you must amend.
Once your divorce or legal separation decree has been entered, or even an annulment in some jurisdictions, the final alimony and property division awards need to be analyzed for any tax implications. The same characteristics required for taxable/deductible temporary alimony are required for final alimony. However, you must consider additional factual and timing issues for final alimony. For example, there is a risk that any alimony that is to decrease or terminate during the first three calendar years following entry of the decree may not be treated as taxable/deductible alimony, despite the parties’ intentions. Or, if your alimony is to terminate or decrease at a time or times associated with your child’s emancipation, the IRS may deem those payments as nontaxable/ nondeductible alimony. These are fact and timing issues that you and your attorney need to explore.
Most divorce-related property settlements are not taxable events. Usually no gain or loss occurs on property transfers between former spouses pursuant to a divorce decree. If the proper order is used, a mere transfer of qualified retirement benefits from one former spouse to the other as part of the divorce can occur without tax or penalty. If the parties sell a marital asset as part of the final resolution, normal taxable principles apply. A cash-out of assets, such as selling stock or retirement funds, will have income tax, and, possibly penalty, obligations, whether the parties made the cash-out before, during, or after the divorce. Sale or cash-out of jointly titled assets will require a determination of who claims the taxable proceeds on his/her returns, which should be addressed in the court’s final order or the parties’ settlement agreement.
Attorney’s Fees and Costs
Attorney’s fees and costs, incurred in obtaining a divorce, are not generally deductible. However, attorney’s fees paid for tax advice and in securing alimony may be. Talk with your attorney and tax professional about these issues.
Taxes are complicated, and can be more so when marital status is changing. Your lawyer should be well versed in these areas, and able to guide you or refer you to tax experts as needed. The information provided here and much more can be found in Divorced or Separated Individuals, a publication prepared by the Department of the Treasury, Internal Revenue Service (Pub. 504, and available for download at www.irs.gov).
About the Author: Brenda L. Storey, who specializes in family law, practices with the Denver-based firm of McGuane and Hogan, L.L.P.
This article was originally published in the September 2009, Vol 32, No. 1 issue of Family Advocate entitled “Client Manual: You’ve Got Choices”. The manual is available online at http://www.abanet.org. The article is reprinted here with permission of the American Bar Association.