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 2015, 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 2015, 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, find themselves with a lower marginal tax rate. These issues can get complicated depending upon 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 divorce decree 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 decree 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 issue 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.
As you can see, many issues arise in how the IRS treats married versus individual persons, and these are important to address prior to getting divorced, as we will see in our next post, which will address spousal support and recent property transfers.
If you have questions about tax consequences of divorce, contact us – we can help.