Tax rules are daunting at the best of times – and they're more so at the worst of times, such as during a divorce, when you may feel too stressed to face decisions involving your taxes. Yet the choices you make will affect your future, both financially and personally. Here’s where to start.
Tax planning in a divorce
- Filing status. For tax purposes, the timing of your divorce matters. The date of your final decree determines your filing status, which in turn has an impact on what you’ll owe.
Will your divorce be final by the last day of your tax year (generally December 31)? If so, you’ll file your income tax return as single or head of household. You can also use one of those filing statuses if you were legally separated according to the laws of your state by the end of your tax year.
If your divorce is closed after the end of your tax year, you’re considered married for that year. In that case, you’ll choose between married filing jointly and married filing separately. Head of household status may be available in certain situations.
Tip: Remember to adjust the income tax withholding statements you have on file with your employer.
- Exemptions. When you prepare your federal income tax return for 2013, you can deduct $3,900 for each qualified child or relative that you claim. In addition, you get the benefit of other credits and deductions related to your dependent, such as the child tax credit.
The general rule: You’re the custodial parent if you’re the one your child lives with for the majority of the year. You can release your claim to the exemption by filing a form with your return. The release will also allow your former spouse to claim the child tax credit.
Tip: Consider adjusted gross income and your exposure to the alternative minimum tax when discussing who will get dependency exemptions.
- Asset transfers. In general, ex-spouses can make a tax-free transfer of assets within a year of the divorce. “Tax-free” means the initial transfer is considered a gift, so you’ll want to make sure you’re fully informed about the basis of assets you receive. Why? Because you get the same basis and holding period your ex-spouse had before the transfer.
That will be important when you sell the assets later.
Another caveat: Some types of property, such as retirement plans, have extra rules to be aware of. For example, to remain tax-free, a transfer from your traditional IRA to your spouse must be mentioned in your divorce decree, and should take place post-divorce, via a direct transfer to the new account.
Splitting assets in your 401(k) or other qualified retirement plan requires a “qualified domestic relations order,” a document you must get from the court.
These are just a few of the taxing aspects of divorce. Contact us for planning and advice specific to your situation.