Everyone knows when things turn sour and divorce proceedings have begun to involve their attorney. What many do not realize is their accountant should be involved as well. Many of the aspects of a divorce, alimony, child support, property settlements, custody, and filing status, all have tax, as well as legal ramifications. Often, amid the stress of this trying event, the tax ramifications are not considered until afterward.
- Filing status is one of the more straightforward aspects. If the divorce is final by year end each former spouse is either considered single or head of household (assuming neither as remarried). If the divorce is still in process at year end, things become a bit more complicated. Married filing joint tax filings are usually better from a tax perspective than married filing separate, but each spouse must agree to them, and both spouses are held jointly and severally liable for the joint liability. As a result, what is best financially must be weighed in concert with issues involving trust and communication during a time when these may be strained.
- Alimony and child support are also contentious issues with significant tax effects. While alimony is deductible to the payer and taxable to the recipient, child support is not. Also, if alimony is front loaded toward the beginning of the post divorce period, it can be reclassified as a property settlement, exempt from tax for the recipient and non-deductible for the payer. In addition, alimony and child support each have specific definitions under the tax law which state law may not differentiate.
- Even custody of children can have tax ramifications. Normally, the personal exemption for a child would go to the residential custodian. The residential custodian can also choose to concede the exemption to the non-custodial parent. This is beneficial when the residential custodian receives minimal, or no, benefit from the personal exemption.
Involving an accountant to run projections during the process can aid in clearly illustrating the economic costs of each filing status for all parties during the divorce year. They can analyze the actual cash out of pocket (and net received by the recipient) of allocations between alimony and child support for both parties. They can assist in determining the actual benefits of the dependency exemptions for each former spouse. They can also assist the attorneys by reviewing the divorce agreement and identifying if alimony, child support, and property settlements aren’t being accidentally drafted as one the other for tax purposes. One of the most expensive things in the world is a failed marriage. A poorly orchestrated divorce can only serve to exacerbate these costs.
If you would like to know more about how we can assist in this process please feel free to contact us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director