By: Leslie Barrows
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Income tax issues and options in divorce and family law
During an open divorce case, the parties identify all the income, assets and debts of the marital estate, which are divided between spouses based on Texas law and the Family Code rules applied to each individual case. The Temporary Orders hearing in family court is the proceeding at which the Court orders the preliminary division of financial responsibilities and property.[i] Child support and spousal maintenance are addressed at the Temporary Orders hearing, for which there are tax implications. The Temporary Orders hearing may also include tax liability and issues regarding tax filing status and dependency exemptions. Tax issues can be negotiated among the parties to reach agreements on financial issues. When the individuals in divorce are able to independently decide among tax filing options, a financial and tax advisor can identify the financial benefits and burdens associated with various options.
Tax consequences of child and spousal support
Child support and alimony referred to as spousal maintenance are often awarded on an interim basis in the Temporary Orders. Child support payments are not deductible by the parent paying child support and the recipient parent may not taxed on child support payments received.[ii] The party paying maintenance can deduct those amounts on their income tax return. The spouse receiving maintenance payments must report the amounts as income.[iii] Note however, that voluntary money given between spouses, to pay the other’s rent, mortgage or expenses is not considered maintenance, for purposes of income taxes; only court-ordered maintenance has tax consequences.
Tax exemptions for dependents
The custodial parent who has the child for the greater part of the year, and who is identified in the Temporary Orders as the custodial parent, receives the right to claim the dependency exemption and tax credit for a child, unless otherwise ordered or agreed to by the parties.[iv] The parent entitled to the dependent exemption can offer the exemption to the other parent. If there are other income and expense obligations, the exchange of a child tax exemption may be in lieu of other financial options during the division of the parties’ finances. The IRS Code does not allow both parents to claim a tax exemption, and since it may not be shared, the parties who want to split the tax benefit can estimate the amount of tax benefit and address the amount in a divorce financial agreement.
Tax filing status options
Deciding whether to file jointly or separately depends on your marital status on December 31, of the preceding year.[v] If you were still legally married on the last day of the year, with your divorce pending, you may file a joint return and receive the benefit of a lower tax burden because certain tax benefits are not available for an individual who files a separate return. Despite the tax consequences there are some situations in which filing as married filing separately makes sense. For example, when your spouse refuses to cooperate or you are concerned they may not be accurately reporting their income and expenses, and you fear that filing a joint return with them could subject you to the liability of a tax audit.
Head of Household is another tax filing status option, where you may be considered single despite not yet being divorced or legally separated as of December 31 of the preceding year.[vi] Heads of household filers often pay fewer taxes those filing as single because you are entitled to more deductions and benefits. To qualify for Head of Household status there are requirements you must meet:
- You paid for more than half of the housing and property maintenance payments of the home during the tax year;
- For more than six months your spouse was not living with you in the home;
- Your dependent child lived in the home with you for more than half of the taxable year; and
- You have the right to claim the dependent exemption for your child.
Dividing income and assets in an open divorce
If during your divorce, you sell the marital home there may be capital gains tax liability. Income received from all sources during the tax year must be included in your tax return. Each spouse has an equal right to the income derived by jointly held property, and in divorce, usually one-half of the income from the property is taxable as to each spouse. Deductions from medical expenses, mortgage interest and other itemized deductions can be equally divided or may be solely given by one spouse to the other if both spouses agree as such.
These general rules about taxes, exemptions, credits and filing status options are subject to exceptions. In the event of prior unpaid tax obligations and other complex financial matters affecting tax obligations, a tax attorney works with the family law attorney to help clients negotiate the best tax positions based on their facts and circumstances.
The Barrows Firm represents spouses in divorce with a variety of complex financial and matters.
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[i] Nolo Legal Encyclopedia, Temporary Orders in Family Court: Quick Decisions on Support and Custody.