There are many issues to sort out in a divorce. When spouses disagree it is usually over children, support and money. In the process, spouses may overlook the importance of addressing common tax issues.
The tax dependency exemption for qualified children is worthy of a separate blog.
Here are the other top four:
1. Filing status. Your tax filing status is your marital status on December 31. If you got “hitched” on New Years Eve 2011 you are considered married for 2011. Got divorced as a Christmas present to yourself? You cannot file married for any portion of that year. Ordinarily, the most advantageous filing status is “married jointly.” However, if you are going through a divorce and have questions about the legitimacy of the information provided by your soon to be “ex” you may wish to insulate yourself and file “married separately.”
What if you are legally separated? You are treated as single for tax purposes.
2. Tax refund/tax liability. Spouses should endeavor to agree on a fair division of the refund. If there is no agreement, treat the refund as a marital asset subject to distribution at trial. Same advice to tax liability.
3. Support. Alimony is taxable to recipient and deductible by the payor. Child support is tax neutral – there are no tax implications. “Unallocated support” (child support and alimony rolled into one amount) is treated like alimony for tax purposes. Therefore, in an effort to maximize financial resources (and give Uncle Sam less) it may be beneficial to eliminate the labels of “alimony” and “child support” and explore the concept of “unallocated support.” Sometimes it does “pay” to get creative.
4. Asset division. If done properly, dividing assets should have no tax consequences. For example, most retirement plans can be distributed pursuant to a Qualified Domestic Relations Order (QDRO). But a word of caution. While the transfer (division) of assets pursuant to a divorce has no immediate tax impact there are potential tax implications when those assets are eventually liquidated.