Yes, it is that joyous time of year when we all must pay our federal and state income taxes, and for newly divorced persons, with or without children, the sudden change in status could have very real consequences for your financial bottom line with Uncle Sam. So we thought we would offer some helpful hints as you sort through your receipts and sharpen your pencils (mechanical or electronic).
First, the most important fact to address is your filing status. If you were divorced during 2023, you cannot file as a married person anymore. It may seem obvious, but many people wonder why if, for example, they did not divorce until December of 2023, they cannot take advantage of the married filing status for that period of time. A good point as far as fairness, but the IRS uses a very straightforward and rigid rule: if you are not married on December 31 of a given year, you cannot file as married.
Why does filing status matter? Generally, married people can pay a “marriage penalty,” which happens when two spouses would fare better filing individually than filing as a unit, and by fare better, we mean have a lower marginal tax rate. In houses with two significant wage earners, the marriage penalty can be severe. On the flip side, when married people get divorced, at least one spouse, if not both, finds themselves with a lower marginal tax rate. These issues can get complicated depending upon the level of gross income and whether it comes from salary or as a sole proprietorship, but the general rule usually holds.
Second, who can you claim as dependents? Generally, children tend to be the most typical dependent, and the IRS has a strict rule regarding which parent can claim the children: the parent who has the children at least 50% of the time during the year. If both parents have joint physical custody with equal time, the parent designated the residential parent would likely be the parent to claim the children. However, if in the parenting plan the court awarded either alternating tax exemptions or allotted one child to one parent and one child to another parent, those provisions govern. Please note that even if your parenting plan sets out these exemptions, you may still be required to fill out a waiver form. Typically, the IRS will flag the social security number of a dependent and if the number shows up on more than one return, a letter will be issued that could trigger an audit, as only one parent can claim a child. Thus, if you want to avoid an audit, do not claim as a dependent any child you do not have a legal right to claim as a dependent.
In addition to the benefit of claiming the child as a dependent (each child reduces your gross taxable income), the parent who can claim the child as a dependent can also claim the childcare tax credit. If you can claim the child as a dependent and you pay work-related childcare for that child, those sums will get you a tax credit up to a certain amount. Again, as with the problem of improperly claiming a dependent, do not try to claim the childcare tax credit if you cannot claim the child as a dependent – even if you pay the childcare.
While the IRS may seem harsh in who claims a dependent or the childcare for the dependent, the IRS is more generous when it comes to paying for healthcare expenses for a child. Very simply, if you paid for any healthcare expenses for the child, including insurance premiums, you can claim those as your healthcare expenses.
Finally, the IRS also allows a person to claim head of household. To enjoy the benefits of this status, you must have the ability to claim the children as dependents. If you and your former spouse would reap greater refunds by splitting exemptions, you can reach an agreement and sign a waiver to the other to claim one or more children for that year, in return for sharing the greater refund.
Maintenance (i.e., spousal support), which is called alimony in other states, is a payment made by one spouse to the other pursuant to a Judgment of Dissolution of Marriage, Judgment of Legal Separation, or Judgment Pendente Lite (i.e., temporary order while a divorce is pending). As of December 31, 2018, maintenance payments are no longer tax deductible by the payor, and they aren’t required to be reported as taxable income by the recipient. However, if you were divorced before December 31, 2018, and maintenance was ordered, the payor spouse is eligible for a tax deduction for their payments and the recipient spouse must record the payments as income on their tax return.
If you are ordered to pay child support, please note you cannot claim any of those amounts as deductions on your federal taxes.
If you divorced last year and you had to sell the marital home, the tax consequences could be tricky. If you sold the home for a profit, that profit is taxable as income or capital gain. However, if you take the proceeds and use them to buy a new principal residence, you will not have to pay any tax on the profit. Unless otherwise stated in your divorce judgment, if you and your former spouse both owned the home jointly, you will both be responsible for the tax issues related to the sale.
If you divorced last year and the court awarded a division in retirement accounts, you could have tax consequences. In general, any early withdrawal from a retirement account carries both an income tax and an early withdrawal penalty. So, to avoid the harsh tax loss, roll over any shares in retirement funds into your own retirement accounts or a separate new account for these benefits. Also, you may need a Qualified Domestic Relations Order (QDRO) to effect the transfer. Also, if you feel you need to access funds, going to withdraw newly received retirement benefits should be a last resort given the severe tax impact; you would be better off taking out a loan.
As you can see, property issues can be landmines for hidden taxes, so it helps to know what different types of transfers or encumbrances will do to your bottom line.
Should you need the assistance of an experienced divorce attorney in Creve Coeur and O’Fallon or have questions about your divorce situation, know that we are here to help and ready to discuss those questions with you.